Trading Options: Using Technical Analysis to Design Winning Trades, + Website

CHAPTER 1

Identifying the Major Trend

This chapter explores the tools used to determine the major trend in the market and what large-scale outside factors may change it and how. By the end of this chapter you should be able to identify the major trend on a chart and begin to understand how other markets can change that trend.

Why do we need to identify the trend in the first place? If you consider that the four large indexes listed previously hold 2,630 stocks and the vast majority of the market capitalization of the entire market, they are a good approximation for the direction of all stocks. Identifying the trend, then, is like knowing which way the wind is blowing when you are raking leaves or which way the current flows in the river. No matter which individual leaf you are trying to pick up, it will be blown by the same breeze to some extent. It helps to do some of the work with the wind behind you, and it is easier to move your boat downstream than against the current. Trading or investing with the direction of the trend is the same. The trend helps give every stock a tailwind to some extent. That makes sense, right? If the Standard & Poor’s (S&P) 500 is going up, then on average all 500 stocks included in the index are also going up. If all of the other indexes are rising as well, then there are, on average, 2,630 stocks that are rising. However, we know in practice that not all stocks move in the direction of the major trend all the time. In fact, the indexes themselves ...