In this post I will be talking about the most important kind of analysis I do which would be trend analysis. I have previously written a piece of the components of a trend but I did so while I was an intraday trader and I really think that it should be updated. The reason I decided to rewrite it is because there are swing trading principles that are very important that I left out. The last one focused a lot on the moving average part of trends and I will go over that as it is a critical part of trend analysis. Nothing I am going to be talking about here is complicated in the slightest, in fact it is extremely simple. Understanding it is not the hard part for most traders, the hard part is focusing on it. So here are the four components of a trend we will be looking into:
- Short & long term trend
- Swing highs and lows
- Moving average direction
- Relative performance
Short and Long Term Trend:
The easiest way I can describe this is the trend of the past quarter as the short term trend, and the trend of the past year as the long term trend. This is typically represented as a 50 day average and a 200 day average. The people that are looking for top performers in the market will look for prices to be above both of these moving averages, but specifically the 50 day average (the short term). The strongest stocks in the market hold above a rising 50 day average. The market wants performance, not value. Understanding how to use a 50 & 200 day average is simple enough, but understanding the meaning behind them is powerful.
Here is a chart I put together of GOOG (click here). You can see the entire time the long term trend was moving higher, but there were periods where the shorter term trend turned lower. In a rising long term trend, the market is not looking to give out great short setups. The market would rather you be patient enough to wait for the short term trend to turn back higher and trade to the long side in conjunction with the long term trend. Once the short term trend turns back higher, tools like 10 and 20 day averages, blending in lower time frames (65 minute, 30 minute) become very useful.
Swing Highs and Lows:
The fundamental part of a trend is the process of either making higher highs and lows, or lower highs and lows. Professional traders are focusing on these kinds of things while the amateurs are focusing on useless things like a MACD or the latest indicator uploaded to their platform. Here is a link (click here) of a chart of ORCL making a series of higher highs and higher lows. You can bet that on that first higher low, then a higher high afterward that the market started paying attention to this stock. It won't always be this picture perfect, it will take practice on your part to identify what is going on. Also understand this is only one component of a trend, I'll do my best at the end to put it all together.
Moving Average Direction:
This is something I see being discounted a lot by those that don't know any better, but closely watched by those that understand. I somewhat touched on this in paragraph two of section one (I've always wanted to say that) but I want to give this its own section due to the importance of it. The fact that price gets above a 50 day average is not good enough when the direction of the average is still heading lower or visa versa. It is a classic retail mistake to start trying to short a stock when it starts to break down from its 50 day average that is in a strong rising environment. Once you have established the environment you are trading in, you can start to look at other things like 10, 20 day averages and lower time frames as I said earlier.
Here in MA (click here) this is great example of a stock that has been a very strong market participant with a nice smooth upward trending short term trend, great performance here. There was some great long side trading while the trend was in effect. As you can see, the trend ended with a break below that has continued to hold below and as of now the short term trend is heading lower. Professionals are not trading this to the long side right now.
Relative Performance:
As far as pure trend following goes, the first three sections pretty much cover that. Relative performance is more like a powerful confirmation tool that professional swing traders use to make sure the trends they are following are stronger than the benchmark average. This is actually such an important topic that I will likely do an entire post on using relative performance, specifically to trade S&P stocks. The easiest way to calculate relative performance is to take a ratio between what you are following and the benchmark average. For example in SBUX, you would pair that against the S&P (SBUX divided by SPY). I like to have a 50 day average of the ratio, and I like it to be either trending up with the ratio above it; or trending down with the ratio below it to give me confirmation of my bullish or bearish trend analysis.
Conclusion:
To conclude this I will go through some charts that meet the requirements of being in an uptrend and in a downtrend. Click on a chart to make it larger.
CBS meets all the requirements of a stock that is trending higher. Higher highs and lows are in place with rising short term trend measurements.
DIS is another stock that meets all the requirements of being in an uptrend. Higher highs and lows are in place with rising short term trend.
HSY a great looking stock that is putting in higher highs and lows with rising short term trend.
SU is an example of a stock that is trending lower with lower highs and lows and a declining short term average. Relatively this stock is a mess since the benchmark index (SPY) is rising.
CVX is another stock that is relatively and absolutely weak in this downtrend with lower highs and lows and a declining short term average.
Like I said in the beginning of this post, the hard part for most of you will not be understanding this information. The hard part is knowing that you should be focusing on this and then focusing on it. Refining this understanding of how trends work will be the most powerful tool in your arsenal if you put the time into it.
If you have any question, please use the comments below so everyone can benefit from it. I have it to where you don't need an account to post a comment on my site.
Trade well,
-Michael
