As we continue on through this journey to our first live trade, we have already explored the fundamentals of markets and equities and we have moved our way through the technical analysis aspects of trading.  We looked at charts, trends, and indicators.  We really just skimmed the surface of those two topics.  We got just far enough down the rabbit hole of those two concepts to give us a working knowledge.  Any further into those subjects and we may never have made it to the next step which is where we are at this point.  I encourage you to keep learning about fundamental and technical analysis as you progress through your trading career as it can only help you hone your trading skills long term.  Here at Tackle Trading, we are all about financial education and we know that our learning never stops and hopefully, you will reach this level of enlightenment as you progress.  Albert Einstein said it best…“Intellectual growth should commence at birth and cease only at death.” 

At this point in our journey, we need to start gathering the information required to put on live trades.  Before we do that very thing we need to establish our own patterns so that we can repeat the processes we are going to learn.  This is the point where we have to establish a routine that will keep us streamlined in our information gathering process so that we don’t get overwhelmed or fall into the trap of paralysis by analysis.  The way we accomplish this is to build ourselves a daily routine that we can work through to give us the information that we require to put on solid, higher probability trades.

We need to understand what the market is doing before we can react to it.  As traders, our job is to react to market conditions and not try to predict them.  It is natural to think that we need to predict where a market or an equity is going so that we can jump on that trend and ride the wave.  However, that is not actually the case, all we need to do is to be prepared for wherever the market decides to go.  We want to have an idea of where the market is most likely headed but we can never know for sure and so we must prepare ourselves in case we are wrong.  I am getting a little ahead of myself at this point.  Having an idea of what the market is doing overall is called “market bias” and that is our first step in gathering the necessary information for trading successfully.

The way we determine “market bias” is by looking at the markets from a Top-Down approach.  This means we need to look at the overall indexes, namely the S&P 500(I like to use the futures to discern this information, the symbol for the S&P 500 is /ES in think or swim), the Dow Jones Industrial, (/YM), the Nasdaq(/NQ) and the Russell 2000(/RTY or the RUT).  In addition to these charts, we need to look at the VIX, commonly known as the volatility index or the fear gauge.  We need to look at the weekly charts and daily charts to determine the overall trend of the markets. In addition to the trend, we want to look for support and resistance that might affect where the overall market can go to.

After we look at the overall markets then we want to look at the individual sectors to see which ones are trending up and which ones are trending down as we are trying to trade with the trend of the markets and going against the sector can make this more difficult. Once we have established a market bias and the sectors biases then we can drill down to individual equities.  This is where we look at specific companies inside the sectors that we have determined are moving the way we want to go.  An example of this might be that if we see the overall market as bullish and then we see a certain sector that is also bullish then we can go through the companies in that sector and look for strength.  We will not always be trading in the same direction as the overall markets but it is typically a lot easier to go with the flow.  Having said that, if you are looking in a sector that is bullish and the overall market is bullish and most of the companies are strong but there is a weak one in the bunch, this is defined as a company that is not going up when the rest of the companies in the sector are going up, this shows weakness and we can use this to short this company when the sector decides to reverse.  There is a saying on wall street that goes a little something like this…”Support strength and punish weakness!”   This saying describes the aforementioned scenario.

Below is an image of the Top-Down analysis that we are talking about.

This analysis helps us to determine our market bias or where we think the market is possibly headed or where it has been going recently.  Once we have this bias in mind then we can start to put together individual trades as we have our bias for our individual equities in mind as well.  We need to gather more in-depth information before we actually place a trade and we will delve into that in the next episode.  Until then, try the Top-down approach to the markets and see if your biases are in tune with the market action.