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How To Stay On Top Of The Market

11/27/12 08:43:53 AM
by Billy Williams

Traders move from euphoria to terror as markets that were once on a bullish run turn bearish at the drop of a dime. But if you understand a few concepts, you won't be caught flat-footed.

Security:   SPX, AAPL
Position:   Hold

The market's current breakdown serves as a good example of why you should know how to keep your fingers on the pulse of the market. Last year, around this time, the market was on a tear as the bulls drove up the SPX and other major indexes on a solid bull run that lasted up to April 2012.

Many traders became euphoric as the new trend seemed to find its legs and held the promise of breaking through the decade-old resistance point that has held the overall market in stasis since the dotcom-era stock market crash. Euphoria turned to panic as the market descended into a decline, leaving many traders dumbfounded at what had happened and depressed as the stagnant back-and-forth trading returned.

However, not all traders were caught unawares and, in fact, many are now sitting in cash while refusing to give in to false predictions and false hopes of a rally until they see evidence that confirms that the bulls have control of the market again.

The reason that they are not compelled to enter the market at this point, and exited the market in April 2012, is that they have a method that tells them when to enter and exit without the emotional hangups of missing a move and overstaying their welcome.

FIGURE 1: SPX. On September 21, 2012, the SPX closed its trading day near its opening price while in an uptrend. But selling volume was huge that day and later went to signal a turn in the market as the bears wrestled control from the bulls.
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That is what you need -- a reliable approach to tell you when the market is in trouble. Why? Because 70% or more stocks will move in tandem with the overall market. The force that lies at the heart of the overall market's price movement is the institutional traders who move billions of dollars in and out of stocks as stealthily as possible, but there are key indicators that can help you determine what they are doing and plan your strategy accordingly.

Price and volume are the two major indicators that reveal what the big institutions are doing. Each component has an indirect effect on the other and it's when the two diverge from one another that a warning signal is alerted. See Figures 1 and 2.

FIGURE 2: AAPL AAPL followed the SPX's lead and plunged in share value, trading through the 50-day simple moving average (SMA) and 200-day SMA before finding support. However, it's still not a sure thing if AAPL or the SPX will recover yet.
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When the markets are healthy, volume grows and swells, causing price to steadily move upward because as traders and institutions begin accumulating shares, supply & demand take effect and share value increases as a result.

If price continues to rise but selling volume rises, it reveals that the common trader is continuing to buy & hold but the major institutions are looking to exit their positions and are selling off in odd-lot positions to try and hide their intentions so they can get out at the best prices. This can happen for any reason even if the company is doing well fundamentally, so knowing how to read the amount of distribution in a stock is invaluable so you don't get trapped into overstaying your welcome because the stock is a good value.

Value is a relative term because the only thing that counts is if the stock is going in the direction that favors your position; price movement should be your emphasis, since that is what determines your profit. So be sure to watch how price and volume react to each other's movement and gauge whether the market is under accumulation or if the market is revealing that big institutions are distributing their position and whether you should exit quickly.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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