Even with Nike earning report that released Dec 18,2020, the Dow 30 index still overvalued compared to the Sam 30 index that I released in the previous post.
Dow 30 as Dec 21, 2020
Sam 30 as Dec 7, 2020
Same 30 as Dec 21, 2020
Sam 30 compared to Dow 30 AS of Dec 21, 2020
As you can see above Sam 30 as of Dec 21, 2020 has jumped up as a result of increase in Nike stock value with 75.36 points but it still shows that Dow 30 is overvalued since the difference between the two is 7,489.81 points for the Dow 30.
And as discussed in the previous blog when I explain Sam 30 and how it works with Dow 30, when Dow 30 is greater than Sam 30 then it means that Dow 30 is overvalued, and when Dow 30 is less than Sam 30 then Dow 30 is undervalued, and when they are equal then that means the market is has fair value.
The Dow 30 index is a general index that measure the sentiment of the US equity market as well as investor in long run since it consist of the main 30 companies that affect the market and the economy in general. This index shows if the market is going in uptrend, downtrend or sideways. Because of that I used this index as a base for my analysis and I used all companies inside this index in order to come up with my index which shows the real value of Dow 30 index. My index which I am going to call it Sam 30 index is based in Dow 30 index as benchmark to all investors and traders alike to see if the Dow 30 index is an overvalued or undervalued or has fair value.
I am not going to describe the process that I did to come up with Sam 30 index, instead of that I am going to discuses how does Sam 30 index can be used in conjunction with the Dow 30 index in order to allow investors and traders see if there is an opportunity to go long or short or even to step aside and do nothing.
Let us assume that the Dow 30 is 30,000 points and Sam 30 is 23,400 that means the Dow is greater than Sam 30 with more than 6600 points, which means the Dow 30 is overvalued and investors should not invest in the market , and traders on the other hand should apply their technical analysis to see an opportunity for shorting any overvalued stock in this market. The same is true if the Dow 30 was 23,400 points and Sam 30 was about 35,000 that means the market is undervalued and investors and traders should look for an opportunity to go long with any undervalued stocks.
Sam 30 is not day by day index, instead is an index where its value updated whenever new earning report released by the companies that built the Dow 30 index. Once the earning report released for any company of those 30 companies that listed in Dow 30, Sam 30 index will be updated to its new value in the next day.
As of December 7, 2020 the Sam 30 value is 22,495.92, that means, when we do our analysis that described above, the market is overvalued
Comparison between Dow 30 and Sam 30
As you can see above the Dow 30 is greater than Sam 30 with more than 7,700 points which means that the market is overvalued and I suggested that investors to step back and do nothing while traders can short any overvalued company based in their technical analysis.
A lot of traders are using indexes or at least the major one to see if the market is going up or down or does not move in either way as sideways movement. This a very helpful technique that used by traders and investors to see if the market is willing to pay some profit in either way by going long or short, or if the market is not moving at all which can be better to stay out of it.
Many traders and investors alike using S&P 500 as a gauge for market sentiment to see if the market is about to have a new breakout move or continue its original one before they trade or invest in any stocks. This approach is more helpful for traders and investors because it will prevent them to invest or trade in phases where market is not going any way, or even worst when it move or start move in downtrend.
But the question to ask here, is measuring market sentiments by using S&P 500 is a good approach or there is another index that is better in measuring the market sentiment rather than S&P 500.
Before answering the above question let us understand what is S&P 500 and how can be calculated?
S&P 500 is simply an weighted average for 500 companies. These companies are the most largest companies in U.S economy. Some of those companies have higher weight than others based in their size and how big financially are such as Apple, Microsoft. As the name imply there are 500 companies in this average. Some of these companies are consider leaders of U.S Stock market, such as Apple, Microsoft, Google, Amazon, while there are so many companies that included in this index are considered a lager companies.
From statistic point of view, when the sample number is increased the average for that sample is almost coming to normal and anomaly will be disregard. To make this simple, when there is a bad companies in that average are mixed with good companies, the value of those bad companies will be disregard since their value will not affect the average specially if those companies are smaller in weight than those good one. That was the reason that S&P 500 index broke the top that made in Feb 2020 in beginning of this year, even if there were so many companies are reporting bad earning report.
But what if the sample size is been minimized to 200 or 100 or 50 or may be 30 such as Dow 30 index. What will happen in this case?. The answer is obvious, the average will be more sensitive. That means when there is an anomaly appear, the average will effect immediately either if that anomaly was good or bad. And here comes the important to take Dow 30 index which is known as Dow jones industrial average as measurement of market sentiment.
Dow 30 consist of the biggest companies of all sectors of the stock market. It vary from technology companies to petroleum companies as well as banks and pharmaceutical companies. The variation of these biggest companies and the limitation of this average to consider only 30 biggest companies in U.S economy which make this average a unique market sentiment specially when investors or traders want to know if it is a bull or bear market.
For example, in 2020 where coronavirus pandemic started the market wiped all its profit since 2016 in just five weeks. All other indexes such as S&P 500, NASDAQ and other European indices have been recovered from that drop except the Dow 30 which still failed to reached the top that made in Feb 2020 as shown in the pictures below:
As we can see from the above charts there was an anomaly. These indices should be aligned with each other and broke the top made in Feb 2020 in order to prove the sell off that started in Feb 2020 has been recovered, but since Dow 30 still did not break that resistance made in Feb 2020, it will be hard to tell if the market has been recovered from coronavirus effect or not.
Alignment for all indices is important in order for traders and investors to tell if they are in bull/bear market, and Dow 30 index shows through years if the market is in uptrend, downtrend or sideways. That does not neglect the importance of S&P 500, or NASDAQ composite, they are both good tools to measure the market sentiment, but when it come to overall result, I believe Dow 30 has the final word to decide if the market is about to move either way.
A lot of traders trying to build their strategy based on indicators such as moving average, MACD, RSI or mix of all of them. They forgot that when they are trading they are betting on the price which is the only right indicator. They are not betting on moving average being crossed or not, or if the MACD crossed the signal line or even if the RSI cross the 50 level or not. All these indicators are fine if they are used probably and as a confirmation for your trading the price action, but if they are becoming the main indicators they will end trade up with massive loss.
The only thing that can e consider as main tools that can be used in trading is the support and resistance and the trendline. The reason is not because these tools are help you to indicate the price movement, but because these tools are very good help for trades to tell her that in these are of trend lines and support and resistance the price always work in different way as expected like if it was going up then it might move to sideway or go down immediately, or if it goes down then it might shift its direction to move to the other way sharply.
These tools (trendline, support and resistance) should be drawn carefully on the chart. For the armature trades these will be just consider a punch of lines which will be placed on the chart whenever a level of retracement happen. But that is not the case. They are like a history for the previous price action against these levels and how it acts according to these level. So these level should be placed carefully and with concertation. Here is so tips that will help to how draw ( Support and resistance, as well as Trendlines).
You should consider bigger time frame when you draw these lines. Not below Monthly timeframe even if you are trading in hourly based. Because Major support and resistance or trend line of monthly time frame will never be broken because trader juts think that she bought an engulf bullish candle above strong support in ( 1 hour, 4 hour or even daily time-frame). Below is an example of good entering in EURUSD in 4h time frame.
The above chart shows how the support created first with large engulf bullish candle and how the price traveled higher and then return to the same level and it also when it reached to that level another engulf bullish candle has been created which increase the odd successful swing trade to 1.1990 level. But the truth was not like that and here what happen
As you can see in the above chart the trade that its idea created based on 4h timeframe, could not break the monthly down trend which is more stronger, and the price not reached to its previous support and resume its strength , instead of that it broke it and went low than that which resume the main down trend for the EURUSD. Check this article that I wrote about how to spot markets next move.
2. Traders should always consider volume when they draw supports and resistances specially for those who trade stocks. Because when price hit support or resistance with high volume that does not mean that the price will move to opposite direction immediately. It means that there is more liquidity at that level and there is high probability price will return back to that level and break it. It depends on the second hit for that level and the volume assigned with the price to decide if it was strong support that will make price go in opposite direction or if this level will be broke.
See in the above chart how does price make a resistance in Apple stock at 81.89 level when it hit it for the first time. Then price went down and then come back to the same level and almost hit it many times but with low volume. Once the price break it with high volume than previous days, it was valid breakout that lead the price to go up from this level which was 81.89 until it reached 140 or near to it.
3. Third approach that can be used in drawing support and resistance is when price moves in sideways. These sideways are consider the most liquidity place where volume is either accumulated or distributed and the next move will be decided inside these places. You only need to draw a rectangle surrounding these side ways and wait for price to break this rectangle and pullback to it and once its resume moving in the same direction with break out then engage.
Mastering Support and resistance as well as trendline is not an easy job. Traders need to do it and practice it all the time in order to develop their price action based edge that will help them understand the market as well as making money out of it.
Stocks market default move as all know is going up unless there is a correction move where prices will go sideways because people collect their profits or down when there is a problem in the company. But that is not the case in Forex Market where the move can be either up when the main currency is stronger than the secondary one or down when the opposite is true. In this type of market, traders who bet in the price action and its movement will find it hard to spot which move is the correct wave and which is the correction wave. It will be hard to know which one the actual direction of the price and which one is the correction of the actual move. The following is some tips that can be helpful for traders to spot which move of price is the impulse and which is the correction. Once these two movement have been identified trading will become more easier, because traders can stick to the original direction of price whenever an opportunity has been rises.
The first approach to identify the impulse and the correction is to use long time-frame such as weekly or monthly, and try to identify if the price in these time frame has multi[pl tested trend line. Once this trend line has been identified then the impulse will be always with the direction of that trend line, and the correction will be always in the opposite diction of that trend line. Like the figure below:
Another approach to identify the impulse wave and/or the correction wave is using MACD. MACD has two lines, one of which is called the MACD line and the other is Signal line. When MACD line is above the Signal line and all above zero its an uptrend, and when MACD line is below the signal line and all below zero this is a downtrend. But what if the MACD is above the signal line but both below zero line, or MACD is below the signal line and all above zero line. In these two cases the market is in correction phase and once you identify the original trend you can wait until the correction phase end and the price start move with the impulse direction again . Here where you can use the MACD to see if the price impulsing or correcting:
Above Zero line
MACD above Signal line
Above Zero line
MACD below Signal line
Correction in uptrend
Below Zero line
MACD above Signal line
Correction in downtrend
Below Zero line
MACD below Signal line
MACD and impulse and correction waves
As you can see in the below chart:
Note: MACD should be used as secondary confirming tool not as major tool. Never use it by its own, the only major tool that you can rely on is the price action and its movement.
Sometimes the correction wave has an impulse and strong wave where the impulse will be in the opposite direction of the general market, and the correction wave for this impulse is in the direction of market. Here where many traders loss their money in market specially in Forex where there is lack of volume. The only way that will help traders to avoid this types or trades is to make sure that they get in trade with the direction of general market impulse wave after the momentum of the correction wave is faded and that happened when the MACD line is crossing signal line or retrace back from it and all lines are either below zero( for Sell) or above zeros (for buy) which means that the market will resume in the main direction like the figure below.
One of the great tool that can be used to tell if the trend line (either was up or down) about to be broken and the correction wave which suppose to hit the trend-line and resume with movement of main trend line direction is about to become an impulse, is using a momentum tools such as (RSI). Once the price reached a down-trend such as the one in the figure below with high RSI that either at 70 or above , then there is a high probability that the price will valid break the trend line and move up in new up-trend and new impulse wave.
Those are some tips that might help traders in how to indicated which move is the correct one (impulse) and which one is the correction move. Trader need to stick to the original move and avoid trading in correction move especially if she is not experts. Because as I said before all money that traders make in the original move can be wiped of and more once the price get in a correction wave.