To the average investor the stock market can seem complicated and confusing. Stocks can go up or down for no apparent reason. Stock A reports great earnings but the stock plummets. The price of oil drops and the inflation report is tame but the major stock market indexes dive. Stock B reports terrible earnings but the stock rallies. When it comes right down to it, the reason why stock prices are going up or down seems to be anybody’s guess. You might as well try to read tea leaves.
This may sound like ‘financial heresy’ but I really don’t care why stock prices move up or down. Highly paid analysts would have us believe that a company’s fundamentals drive stock prices. Yet how many times have you seen the stock of companies with good fundamentals crash while those with terrible fundamentals soar? But none of that matters for one simple reason…because at the end of the day, if there are more shares being bought than sold then the price of the stock will go up. And, if there are more shares being sold than bought, then the price of the stock will go down. It’s just that simple. Everything else is just noise.
To make real money in the market you don’t need to know why a stock price rises or falls, you just need to know in advance which way it’s most likely to go. If you can quantitatively measure the buying and selling pressure of a stock then you will know in advance whether the price is likely to rally or decline.
Successful trading can be reduced to two simple rules:
- Buy investments if the buying pressure exceeds the selling pressure
- Sell investments if the selling pressure exceeds the buying pressure
The best way to measure buying and selling pressure is to track the price trend of the daily closing price of a stock. If the daily closing price of a stock is increasing then the buying pressure is exceeding selling pressure and the stock should be bought. If the daily closing price of a stock is decreasing then the selling pressure is exceeding buying pressure and the stock should be sold.
One of the most important rules I learned as a novice investor was that you want to purchase a stock only if the buying pressure exceeds selling pressure as indicated by the closing price of the stock trending up.
Trying to profit by investing in a stock with a closing price that is trending down is very difficult as it requires that you correctly predict when the price of the stock will ‘bottom out’. This is often referred to as ‘trying to catch falling daggers’. Buying a stock because it is cheap and then trying to predict when a stock’s price will bottom out can be nearly impossible to forecast correctly on a regular basis. This ‘crystal ball’ type of approach can leave the investor in a vulnerable position. A safer approach would be to wait until a stock’s closing price is in an up trend before investing. Patience will often pay off handsomely if the investor is able to embrace this virtue. A stock’s closing price movement reflects all of the known information about a company so let the price movement of the stock tell you when you should invest.
“He who lives by the crystal ball soon learns to eat ground glass” Edgar R Fiedler
There are hundreds of indicators available that help you pick stocks. The more complex an indicator is, the more difficult it is to use and the higher the probability that an error will occur. ‘Keep it simple’ is my motto. I try to instill this into my life as often as possible. I also try to translate this philosophy into my investing. You can look at formulas that are complicated enough to put a man on the moon or you can keep is simple and look at trend lines that track the closing price of a stock. Trend lines work and are easily understood. That is why I prefer to use them.
“Life is really simple, but men insist on making it complicated” Confucius
The goal of the Trend Line Indicator is to determine whether a stock’s closing price is in an up trend or down trend. This has to be established before you invest in a stock. Investing with the trend is a basic principal that is required for successful investing.
Rely on the Trend Instead of Predictions
The best time to invest in a stock is when its upward closing price trend has already been established. Unfortunately, the novice investor tends to purchase ‘cheap’ stocks that are in a closing price down trend hoping to pick the bottom of the price movement. Stocks that are in a downward closing price trend should be sold. A wise investor will look at the closing price trend for assistance as the closing price trend will reveal in advance which way the stock price is most likely to move. Closing price trends are not predictions. Buying a stock with a closing price down trend is asking the investor to be a forecaster.
(The following is an excerpt from John Weston’s Shoestring Millionaire)