Building stock supply
STOCK PRICES MOVE AS A GROUP
One concept that all analysts agree on is that stock prices tend to move as a group. Dow Average, Standard and Poor?s and NASDAQ stocks tend to move as a group. If they diverge from moving as a group, it is a signal of weakness in the stock market.
The tendency of stock prices moving as a group is what makes up a trend. Divergences are changes in trend that show stocks not moving as a group. It is difficult to know whether the signal means a change in trend or the appearance of a secondary trend. However, the divergence is a technical signal of market weakness. There are also times when divergence signal and continues to move upward. The investor who is aware of trends has the advantage of knowing whether the market is strong and in what direction it is going. First the divergence signal, then the reaction, followed by a turn in direction.
II. SIGNALS
Signals can be confusing; a market trend can ignore what is supposed to happen and continue on its merry way. It is able to do this because it is a market of individuals making judgment calls.
Often active investors wait for someone else to make a move. Groups form, believing the market will fall. Other groups form and take actions to prove the first group wrong. As the struggle ensues, buying and selling groups will gather and lose supporters until finally a majority of buyers or sellers emerges. The participants in this struggle will search out news and information to support their belief. If the news suggest their stand is incorrect, they will switch sides and the market will move accordingly.
All the individual investor has to do is look for signals of a struggle of weakness. Such signals will often appear in trend divergence. It can be a divergence between the Dow Industrial Average and the Transportation Average or it might be a divergence between the Dow and an individual stock.
III. A TREND REMAINS IN FORCE UNTIL IT CHANGES
A trend is a line drawn on a graph by connecting the points representing the closing price levels of a stock or point levels of an average or index. Trends of the stock market and of individual prices are an important part of investment analysis. Technical analysis and stock traders follow trends religiously. Even fundamental analysis keeps an eye on trends for the same idea of strength and direction.
There are three types of trends in the stock market.
Primary trends ? The long term trends of the market over months and years.
Secondary trends ? Short term trends of a few days or weeks, running contrary to the long term trend . Tertiary trends ? The daily movements of the stock market.The strongest trend
The strongest trend is the primary trend. The market can have expected or unexpected weakness where the Dow Industrial Average drops more than 500 points but recovers. In these situations, the primary trend remains strong.
When an uptrend changes direction and breaks through the trend line, it is a signal of stock market weakness that could become a reversal. Breaking through the trend line is the key indicator. Sometimes the signals are false and the primary trend continues. Other times the trend turns. It all depends on what happens after the trend line has been crossed.
IV. A BEST FIT APPROACH
There are many opinions as to where trend lines should be drawn. The ideal is to figure out where the professionals think the trend lines are located. Interestingly, this trends to be where the trend line fits best. Several data points are connected by the line. The line shows examples of support when the market is trading above the trend and resistance when it is trading below. If there are secondary trends, it is easy to see the market usually correct sharply if the trend line is penetrated. It takes practice and experimentation to see which line placement is most effective.
V. DATA POINT EXTREMES
Some say to draw trend lines at data point extremes. This does not work well because doing so totally bypasses many secondary trends. Although the trend line will show some areas of support, it will not show resistance. Drawing lines at extreme ends of data may work for technical patterns, but is not effective for reliable trend lines.
VI. LENGTH OF TIME
Here again, the length of time a chart covers is up to the person making the charts. Twelve to 18 months are usually good for determining the primary trend. Once that is established secondary trends are easy to see.
A longer period chart can be an interesting reference for the analyst to see where the current trend is coming from. If we look at the long term chart from 1994 through 2004 some interesting points; a good bull market uptrend from 1994 to 2000, with strong secondary action in 1996, 1997 and 1998.
VII. FINAL NOTES
Although plotting trends can help an investor understand the stock market, it is important to remember the factor of anticipation. The stock market constantly attempts to anticipate what will happen next. Anticipation is often unfulfilled or entirely incorrect. The trend remains in force until the trend changes. The difficulty is in knowing if the trend has changed or a correction is just a secondary trend. That is why the market trends to correct sharply if the uptrend line is penetrated. Also, like other stock market indicators, the importance of the trend can be over bidden by other events.
It is easy to see the primary trend turn in February of 2003 and go into an extended uptrend. A weakness occurred in March 2004 that could become a larger concern. At the time the chart was made it was impossible to tell if it would be an actual turn in the primary trend or was just a secondary trend development.
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