Understanding Broad Market Behavior is Important When Trading Stocks

Traders who are looking to capitalize on short-term price movements will generally focus on individual stocks. This narrow focus does not mean you shouldn’t pay attention to the broad market as a whole. Understanding what drives the market and what influences the direction of the trends will set you up for success.

The Big Picture

To understand the current state of the markets you have to first identify the current economic climate. There are a number of economic indicators that can have a powerful effect on market movement. The four primary factors are:

• Interest rates – Are rates rising, falling or staying the same?
• How is business – Are areas such as industrial production and consumer spending up or down?
• The Fed – What does the Federal Reserve Board think about the future of the economy?
• Individual sectors – The economy moves in cycles. What sectors are doing well? What sectors are lagging?

Go With the Flow

Think of the broad market as a river and as a trader you are inside a canoe in the river. Will it be easier to paddle upstream or downstream? Clearly you have the ability to go either direction but attempting to go against the flow of the river will require additional effort.

The market is no different. On some days the market will be trending upward and the majority of the stocks in the market will also be trending up. Other days the market will be heading down which means most of the stocks will also be going down. If you can determine which direction the market is headed and trade with the trend you are more likely to place successful trades.

Size Up the Market Before Trading

Each day before you make the first trade it is important to take a look at what the markets are doing. Identify if the broad markets are trending up or down, then determine what individual sectors inside the market are doing. This top-down approach will help you focus your trading strategy and allow you to filter out potentially poor trading ideas.

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