I love surprises… on my birthday, not in my trading.  This means that as a trader, I must be aware of any and all dangers that may affect my positions.  One way to eliminate adverse surprises in trading is to practice what I call ‘Total Market Analysis’ (TMA).  Total Market Analysis involves analyzing a security on multiple timeframes in addition to analyzing multiple markets.  By doing this, a trader can be made aware of dangers (support, resistance, patterns, etc.) that may not be visible in the analysis of their selected ‘trading timeframe.’

 

Many traders make the mistake of getting too caught up in the analysis of their security.  Often, the signal for a reversal in price is found on a related stock, the sector the stock belongs to or the broad market.  Roughly 60% of a stock’s move is related to the direction of the broader index.  This is true even if the stock is moving in an opposite direction of the index. (See Figure 1)

About 30% of a stock’s movement is influenced by the sector that the stock belongs to.  That only leaves 10% of a stock’s price movement that is company specific.  Why do so many traders feel it is necessary to spend so much time analyzing the stock and ignoring the larger influences?  Total Market Analysis requires the trader to analyze nine charts for the stock they wish to trade – three timeframes on the stock, three timeframes on the sector and three timeframes on the index.  It may seem like a daunting task, but with practice Total Market Analysis becomes streamlined and second nature. 

To begin, a trader can focus on either a ‘top down’ approach or a ‘bottom up’ approach.  The ‘top down’ approach begins by analyzing the markets as a whole and determining the overall direction as well as probable turning points (supply and demand levels) of major indexes.

The next step is deciding which sector will best participate in the movement.  Some sectors will outperform or underperform the broader markets in different economic environments.  Knowing this yields an edge.  There are a few free websites that measure the correlation between sectors and an index.  Visually comparing charts is another good way to determine the relationships.  Once a sector has been identified, select an individual stock to trade.  The trader has a choice here.  Trade the leader or the biggest weighted stock in the sector.  Or, choose a laggard with a lighter sector weighting that may follow the other stocks.  My choice is the laggard as I have added an additional indicator – the leading stock. 


This is an excerpt from October 2009 issue of Trader's Journal.