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If you want to understand index graphs and use them effectively to trade stocks, it’s going to be like everything else in life: You get good with practice. First, find the trend. The stock will be trending upward, downward, or staying flat (labeled consolidating).
If there is a trend present, you would like to know how long the trend would last and if the stock has already gone through a pullback. Stocks that are trending have pull backs that allow buyers to purchase a stock that’s trending upward with a low risk buying opportunity or stock that is trending downward with a low risk shorting opportunity. Stocks can trend strong or weak, and you can use the Average Directional Index (ADI) indicator to judge a stock’s strength.
You want a high reading from the ADI Indicator because when a stock is weak, a trading range can develop, making a stock unpredictable.
Elliot Wave Theory
The Elliot Wave Theory posits that a stock goes through five waves. Wave one breaks the stock from a downward trend, beginning a new upward trend. Wave two is the first pullback; this is the time to make your investment if you are not already holding the stock. Wave three enjoys the longest and strongest upward trend. Waves four and five are not nearly as strong as wave three and may be punctuated with a pullback. If you get into a stock at this time, you may make some gains, but nothing too exciting.
Moving Average (MA) and Volume
Moving averages determine a trend direction by smoothing out price data. The price data leads, and the moving average indicator is formed from that price data. It is a lagging trend indicator that can be used to find support and resistance. Moving averages of 20, 50, and 200 days are commonly used to show support or resistance for an occurring trend in a security. If a stock’s advance is supported by the moving average for a period of time, and then the stock begins to break downward, resisting the moving average could cause alarm. You can compare moving averages; if the 20-day MA is above the 50-day MA, the stock is trending up. If the 20-day MA is below the 50-day MA, the stock is trending down. Volume is simply how much of the stock is being traded. A high volume of trading on an upward trend reflects confidence in a stock, and vice versa on a downward trend. Make sure to know whether you want to be a long-term investor or a short-term trader and identify your strategies accordingly.
