Starting to trade the stock market while things are going great and prices are rising can be rather daunting when you don’t know where to start. Add the fact that we’re in a recession at the moment and things can start to look even worse. There are just so many ratios, statistics and chart indicators that you would be forgiven for suffering ‘information overload’.
The first place to start when analysing a company’s stock is not the stock itself but the market.
What does that market tell you about the direction it is heading? Is it in an upward or a downward trend? Charts of the main index can tell you this by a quick glance. If the line is heading downward then it’s in a downward trend, but with the chaotic nature of the index price, how do you know if today’s down is not just a glitch and tomorrow it will go back up again?
The way to analyze the index is by looking at it in several different time frames. First look at the last few days, then the last few weeks, months and then year. What is the general overall direction? If your end point is higher than your start point then you may be in a bull market and it’s time to look at going long (buying). But if your end point is lower then you may be in a bear market and you need to consider going short (more on short selling later).
One of the main indicators that can help you establish the way the index is moving is the Moving Average (MA). This takes the index price over the last specified number of days and averages it. With each new day it drops the first price used in the previous day’s calculation. It’s always good to check the MA of several periods depending if you are looking to day trade or invest. If you’re looking to day trade then a MA over 5, 15, and 30 minutes are a good idea. If you’re looking for long term investment then 50, 100, and 200 days might be more what you need. For those who have trades lasting a few days to a few weeks then periods of 10, 20 and 50 days might be more appropriate.
Technical Analysts (Chartists) use Moving Averages to help them establish when the index is changing direction. These are known in the trade as Golden Crosses and Dead Crosses.
A Golden Cross is when a short average (ie the smallest of the MA periods) crosses above a longer average while both of them are moving upwards. A Dead Cross is when a short average crosses under a longer average while both averages are falling. When a Golden Cross occurs you should be looking to enter a long (buy) trade. If a Dead Cross occurs you should be looking to exit a long trade or enter a short (sell) trade (more on short selling later).
So as you can see, Moving Averages can be very useful in your analysis. However, don’t think that this can be used alone. The Moving Average has a flaw. Due to the nature of it using delayed data, it can give delayed signals. This can be somewhat annoying as quite a lot of profit could be lost before you enter a trade or exit a trade. Always use Moving Averages alongside other signals.