Understanding and forecasting market direction are the keys to profitable trading. In fact, predicting market direction is the foundation for your overall trading performance. If you predict the market direction correctly, the door of significant gains is open to you. Conversely, if your prediction is incorrect, you may incur huge losses.
If you want to understand and forecast market direction in the simplest way, then you are at the right place. We are confident that our simple guide on how to understand and forecast market direction will greatly help you in your quest.
Understanding and forecasting market direction
How can you understand and forecast market direction before the market opens? Here are a few useful tips for you.
1. Use moving averages
Moving averages are simple but useful and powerful indicators that can help you predict market direction. They also give you a reliable signal of when to buy or when to sell a particular asset. In fact, moving averages can serve you greatly even if you don’t believe in technical analysis.
13-day, 20-day, 50-day, and 100-day moving averages are among the most popular for short-term trading. Conversely, if you are a long-term trader, a 200-day moving average guides you in predicting the long-term market trend.
Some short-term traders also prefer using shorter time frames such as 8 or 10-day moving averages. They use them to identify levels of support and resistance as well as observe when one moving average crosses the other. They use crossover signals to buy or sell assets. For example, when the 8-day moving average crosses above the 13-day moving average, they buy. Conversely, when the 8-day moving average crosses below the 13-day moving average, they sell.
2. Use candlesticks and candlestick patterns
Another useful and highly popular technique to predict market direction is to use candlesticks and candlestick patterns. There are several tricks and tips you can capitalize on to correctly predict market direction.
Looking at the previous candlestick
Looking at the previous candlestick gives you a good idea about the market direction. It becomes easier for you if you have basic knowledge about candlesticks. For example, if you have candlesticks that indicate a trend reversal, you can easily predict price direction. For example, if you see a black marubozu candlestick, it indicates that the price will open further lower. Conversely, if a white marubozu forms at the bottom of the chart, it predicts a bullish move.
Looking at candlesticks with long shadows
Candlesticks with long shadows are also considered among the reliable reversal signals. A hammer, shooting star, and Takuri line are among such candlesticks. They all have a very small body while having a long wick. Remember that the color of the candlestick isn’t of importance here. Moreover, these candlesticks indicate the ongoing battle between bears and bulls. For example, a shooting star appears at the end of a long powerful bullish run. The formation of the shooting star indicates that bears have taken control of the market. That leads to the formation of a candle with a long upper wick and a small body. Thus, there are strong chances that the price will begin to decline afterward.
Looking at other candlesticks and candlestick patterns
The above two are examples of making the idea clear. As you know, there are numerous types of candlesticks and candlestick patterns. You should learn about them in order to understand what each of them means. Moreover, two or more candlesticks also combine to form patterns. These patterns can also help you predict market direction. For example, if you know about the “three white soldiers” pattern and see them at the lower half of the price charts, you can easily predict that the price will move higher.
3. Recognize underlying support and overhead resistance
Recognizing areas of support and resistance also helps you forecast market direction. Remember that prices are highly likely to turn back after hitting support or resistance areas.
4. Use technical indicators
You can also use technical indicators to help you predict market direction. The most successful traders and money managers even use technical indicators to have a second opinion. There are numerous useful indicators that you can use such as;
- Moving Averages Convergence/Divergence (MACD) – Helps you get an idea about market momentum
- Stochastic or RSI: Helps you understand whether the market is overbought/oversold
- Bollinger Bands: Also helps you overbought/oversold market conditions
- New High/New Low: Helps you track financial assets making new highs or new lows
- Much more
5. Looking at futures
Finally, futures can also help you forecast market direction. Why so? Because futures traders are typically expert traders and you can follow them if you have an idea. For example, if you observe that values shown on Yahoo Finance are negative, it indicates prices may fall. Conversely, green positive values indicate prices may rise.
Understanding and forecasting market direction – the wrap-up
Understanding and forecasting market direction are crucial for profitable trading. Moving averages, candlestick patterns, determining underlying support and overhead resistance, technical indicators, and even looking at futures help you predict market direction. However, it is also important to keep in mind that financial markets are full of uncertainties. All techniques and tools have their own limitations. That means it is almost impossible for anyone to predict the unexpected. Therefore, many experts suggest using two or more techniques. Entering or exiting a trade after double confirmation maximizes the odds of successful trading.