Being able to determine market direction is a trader’s most important skill, writes Markus Heitkoetter, drawing this three-part series to a close by teaching a simple method for determining market direction.
In this final article from our three-part series "How to Be a Trader," I will show you a simple way to easily identify the direction of the market.
We have already discussed in the previous article that being able to determine the direction of the market is one of the most important skills of a trader because it dictates the type of trading strategy you use. In a trending market, you want to use a trend-following strategy, and in a sideways market, you want to use a trend-fading strategy. For more information on this topic, please review Part 2 here.
How to Identify the Direction of the Market
Way back in the 90s, I used fundamental analysis to try to predict the market. Long story short, it didn't work for me.
Since the mid 90s, I have been usingtechnical analysis in my trading. When using technical analysis, there are two different approaches, chart patterns and indicators.
Examples of chart patterns are flags, pennants, triangles, double bottoms and double tops, etc. Candlestick formations are chart patterns, too.
Examples of indicators are moving averages, Bollinger bands, MACD, RSI, etc.
So which approach is "better,” and should you use chart patterns or indicators to identify the direction of the market?
Easy answer: Use the approach that works for you. I personally use indicators. I like the black-and-white approach. As an example, the RSI is either above 70 or it is not. There's no grey area.
I openly admit that I struggle to identify chart patterns while they are forming. Don't get me wrong, I am an expert in showing you every single chart pattern there is at the end of the day, but I can't identify them with certainty while they are forming. But hey, I can't ride a bicycle either, so maybe there's something fundamentally wrong with me!
Using Indicators to Identify the Direction of the Market
In my own trading, I use three indicators to determine the direction of the market. Today, we will talk about my favorite indicator, which are Bollinger bands. Bollinger bands are a fascinating concept and are available in every charting package.
(Note: If your charting software does not allow you to plot Bollinger bands, it's time to switch to a different software provider. Let me know if you need help finding a suitable charting software platform.)