Monday, November 2, 2009

Using Stage Analysis to trade the Dow Jones

Stan Weinstein wrote in his book 'Secrets For Profiting in Bull and Bear Markets' about the four stages that a stock or market could be in.

In the picture you can see the four stages, and in the next table you can read more about every stage:


Phase


Name


What do we see
Stage 1
Basing
MA 30 is turning flat and the market moves sideways.
Stage 2
Advancing
Trading above MA 30 and the market trend is up
Stage 3
Topping
We see a top in the market and MA 30 turns back flat and the market starts to trade sideways.
Stage 4
Declining
Trading dip under MA 30 and we have a downward trend

I thought, what good is a method without first trying it out in the real world? Well to show you how this Four Stage Analysis method works, I will zoom in on the Dow Jones Index, and see if it really works

A picture says more than a thousand words so please take a look at the Chart of the Dow Jones Index and read the labels to understand how you can trade the Dow Jones using this method.


I will explain it a bit more in detail. I will get into the following:
  • when can I go SHORT at a possible top and when do I exit my position?
  • when can I go LONG at a possible bottom and when do I exit my position?
When can I go SHORT at a possible top and when do I exit my position?

Advancing phase
If we look at the chart at the far left then we see phase 2 (advancing phase), so a climbing Dow Jones. Trading is above the MA30 and the line points up.

Topping
We see that after October the MA30 starts to go flat and we see sideways trading taking place. We draw a support line (support 1) at the lows of the corrections that have taken place.

Breakdown
At the beginning of 2008 support (support 1) breaks down and we see that trading dips under the MA30. This can be a good point of entry for or to take a position but most of the times there will be so-called retest of the breakdown point. So it would be better to wait for that moment.

Retest
Between April and June we see a retest and we see climbing prices up to the support line that becomes now resistance.

Go short on the DOW
We wait until trading goes under the MA30. We also see that the RSI and MACD are pointing downward. At this point we go SHORT.

A little summary:
  • there has been a top phase (flat MA30)
  • MA30 points down 
  • prices lie beneath the MA30
  • support is broken
  • we saw a retest
  • we see a further decline

When do I exit my SHORT position?
When we get back at stage 1 (base) we get out. In the graph that is around 8000$. We see that MA30 goes flat again. The MACD becomes positive and also the RSI. Really certain (what is certainty in the stock market?) are we when we get a breakout through resistance 1.

When can I go LONG at a possible bottom and when do I exit my position
This works exactly the same but then the other way around. We draw a resistance line at a possible bottom (resistance 1).

Bottom
We see here that as from April MA30 starts to go flat and that the market starts to move sideways. We draw a resistance line here (resistance 1) where a high was formed each time.

Breakout of resistance (resistance 1)
We get a first breakout at the resistance line (resistance 1).

Long on the DOW
We see that we get a retest of the breakout level and after that we see a bounce back up. We wait for this moment and also until the trading increases above the MA30 line. We also see a positive RSI  and MACD. Here we go LONG and we close our previous SHORT position.

The trading method when you go from long to short and the other way around, is called SAR, or Stop And Reverse.

Conclusion
If you used this method to trade the Dow Jones you would have made a lot of money. You only had to take 2 positions, one Short and one Long and you could have a good night's sleep. Also the method is an easy method, you have to draw support or resistance lines, and you will use a weekly chart of the market, the MA30 and you are all set. You can enhance it all by using extra indicators like the MACD and the RSI.

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