Wednesdays with Wyckoff: Stock Movement in the Broad Market

Jul 13, 2011: 5:43 PM CST

This week’s lesson from Richard Wyckoff serves as a reminder of the importance of doing analysis (charting) on the broader stock market indexes instead of relying exclusively on the price chart of an individual stock you are considering trading.

Why?  And how does that affect us today?

Let’s hear what Wyckoff has to say on the issue (from Studies in Tape Reading):

“If the stock which is charted were the only one in the market, its gyrations would be less erratic and its chart [would be] a more reliable indicator of its trend and destination.”

“BUT, we must keep before us the incontrovertible fact that the movements of every stock are affected by those of every other stock.  This in large measure accounts for the instability of stock movements as recorded in single line charts.”

While this is probably well-known by professional traders (and even investors), it might not be so obvious to new and aspiring traders.

In other words, the trend (price chart) of a stock does not occur in isolation – it is affected by all the other stocks in the market, which generally is to say the broader state of the economy.

Sure, there are strong stocks (or weak stocks) that buck the broader market trend, but a large portion of an individual stock’s movement (or chart) is tied to the broader indexes like the Dow Jones or S&P 500 (which is to say, the trend of other stocks in the market).

Generally, it’s easier as an investor or swing trader to position yourself in stocks that are aligned with a rising stock market.  The other option is to try to find the diamonds in the rough that rise when the market falls, or falls (if you short-sell) when the market rises.

Make your job easier – always incorporate the broader trend and structure of the main equity indexes when you are determining whether to trade a pattern or set-up on an individual stock.

Know the general trend of the market along with key support/resistance areas along the way.

Odds are that the stock you are about to trade will have a similar situation (breaking above resistance, or failing to overcome resistance) or if the patterns are not similar, odds are that the outcome of your trade in an individual stock will be influenced greatly by the movement of the broader stock market during your trade.

If you traded a short-sell signal in an individual stock at the end of June 2011 when the broader stock market rose five days in a row straight up off of confluence daily and weekly major support, chances are you were stopped out with loss.

I couldn’t resist continuing the quote from Wyckoff as  he shares a bit of his characteristic imagery that helps us learn these concepts:

“”One stock may be the lever with which the whole market is being held up, or the club with which the general market is being pounded.”

While the majority of stocks tend to follow the broader market trend, there are certain points in time – usually due to broader macro-economic factors – that certain stocks (major industry leaders) lead other stocks in a certain direction while the majority of stocks follow that direction.

If you hear of a stock leading the market (examples have included GOOG, AAPL, CSCO, XOM, MSFT, INTC at times), it’s also a good idea to chart (study) that stock along with the broader market trend itself – in addition to any stock you are about to trade.

To read any of the prior lessons from Wyckoff – complete with imagery and all – check out:

“Absorption and Distribution”

“Life Cycle Stages of a Stock Move”

“Mental Poise and Calm”

“How I Select a Stock for Investing”

“Trading a Stock Breaking Through Resistance”

“Trading in Dull Markets and Breakouts”

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

4 Comments

4 Responses to “Wednesdays with Wyckoff: Stock Movement in the Broad Market”

  1. mybestfunds llc Says:

    Great post. I couldn't agree more, which is why I keep a constant eye on the overall market trend from a variety of vantage points. I summarize these each weekend for myself and others.  Keep up the great work!

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