A Stock is Heading Higher or Lower

A great way to identify and measure the trend of a stock is by using moving averages. A moving average is simply an average of closing prices over a specified time span. Charting software really makes your job easier as all you need to do is specify which time frame you want and the software does the rest. It will lay a smoothed line across the chart for you. You can now see whether or not a trend exists and in which direction it is heading. If the moving average is moving higher and the price of the stock is above it, then the stock is in an uptrend. If the moving average is heading lower and the price of the stock is below it, the stock is in a downtrend. As you can see, this is fairly elementary. Making money is not that difficult when you keep it simple.

If you want to look at trends over a short, intermediate, and long-term basis it will be necessary to use different moving averages. For the short term trend use something between the 10 and 20-day moving average. If you want to focus predominantly on the intermediate and long term trends, you would want to use between a 18- or 21-day moving average for the intermediate trend. For the longer term trend you can use between a 40- or 50-day moving average.

What you will have on your stock charts are two smoothed moving averages: one representing the intermediate trend and the other representing the longer term trend. We often use the 10-day and the 20-day moving averages. You can use just one or the other but using both will help you refine your buying and selling even more.

One rule of thumb in determining whether an uptrend exists is the following: when the 10-day moving average is above the 50-day moving average, and both lines are rising, then an uptrend is in place. A powerful uptrend is in place. A trend in motion tends to stay in motion.

Conversely, if the 10- is below the 50-day moving average and both lines are falling, then a downtrend is in place. Buying calls in hopes of a trend reversal would be foolish. All phases of trend point lower. Picking market bottoms is dangerous!

Remember, when both phases of trend are in sync it gives us the highest probability that the current trend will stay in place. Don't fight or buck the trend. The trend is your friend! If you stick with this simple rule of thumb it will keep you out of trouble and also help you identify those stocks exhibiting the strongest trends. Buying stock and/or calls in downtrends or selling stock short/buying puts in uptrends is not a prudent thing to do. This is like stepping in front of a runaway train. Let the market tell you where it is going. There's no reason to guess.

It should be pointed out that moving averages work great in a trending environment, either up or down. They are useless when stocks are in trading ranges. As you can see, it becomes impossible to determine where prices are headed.

So there you have it... the key to knowing when a stock is in an uptrend or downtrend.