March 15th, 2006 | 
Author: Analyzing Stock Market Trends For Trading Options
Whatever type of trading you do it is vital that you have an understanding of and a respect for trends. Remember the old saying:
The Trend Is Your Friend
Now I want to move ahead with some of the specific strategies I use when analyzing trends and show you how I draw my trend lines….
Firstly, let’s remember that with option trading I use the same indicators as share trading. However, due to the short term nature of trades I modify the terminology and use of trends.
Whereas a share trader would describe a long term term for maybe five years, an option Trader would call a long term trend maybe 6-12 months.
Our first port of call for information is the three month daily chart. After looking at the open-high-low-close for the day, we need to look at the current trends.
I prefer a simplified approach to analysis and this begins with the application of as few lines as possible. Generally speaking, three months worth of daily price movement will have one or two ‘Underlying Trends’.
While your initial entry signals are key to making a trade, it is just as important to trade ‘with the trend’ by ensuring that the most recent three months price movement is in the same direction as the present Daily signal.
Whilst the three month daily chart is our priority, it is worthwhile for us to look at a Longer term 12 month chart and get a feel for the ‘Big Picture’. This can give us valuable information to add to our analysis.
At a first glance the Weekly Chart gives a similar picture to that presented by the Daily Chart. Quite often, however, there will be numerous slight differences between the two. These differences offer a slightly longer term insight of a short term trade by allowing us to view the same information in a more concentrated way.
For example, if today was a normal trading Monday on a particular stock, the Daily Open-High-Low-Close (OHLC) western bar would offer the OHLC for today’s trading period. Because the weekly chart is designed to show the OHLC of the week, it represents exactly the same information as the daily chart—that is on Monday. On Tuesday, the weekly OHLC will carry the Open from Monday, and the OHLC for Monday and Tuesday combined. This continues until the last trading day of the week, usually Friday, where the weekly OHLC is now complete.
Another way of thinking about the Weekly OHLC is as a combination of the five Daily Bars for that particular week. The most important thing to remember about these two charts is that while they show a ‘similar’ pattern, definitive Validation Lines may be in slightly different places and therefore give you a different picture than simply looking at the daily chart alone.
When reading the Weekly chart it is also much easier to get a feel for the ‘Big Picture’ by pre-selecting 12 months worth of price action. Obviously the same rules apply in as much as the most recent three months is priority, although with respect to trend lines and the overall view of the Weekly chart, 12 months worth is valuable.
The most important thing to remember when analyzing the Weekly chart is that you ARE NOT looking for an entry signal. By this I mean it does not concern you what type of pattern or signal the most recent weekly bar shows. The two things that do concern you are:
- Where are the recent Validation Lines, and
- Where is the stock right now in relation to those lines.
Always remember that in short term trading (two to five days) you are not only concerned with where the stock is right now, but more so where you ‘think’ it will be in two to five days time.
Related posts:
Posted in 
Tags: