Market Direction

Sizing up the current market direction gives you a heads-up as to whether it makes sense to invest new money or stay on the sidelines. A strong uptrend gives you a green light to add to positions, while a strong downtrend advises caution.

Since many investors rely on the S&P 500 to represent the market, the easiest way to gauge market direction is to compare the index to its 200-day moving average (MA) (see Figure 2-1). If the S&P is above its 200-day MA, it's probably in an uptrend, and vice versa. The distance between the index and its moving average reflects the trend strength. The trend is strong if the index is far above or below its moving average. It indicates a trendless or consolidating market if the index is hovering near, or crisscrossing, its moving average.

The S&P 500 Index reflects the action of large-cap stocks in a wide variety of industries. Other indexes may provide better indications depending on the particular market sector that you're considering. For instance, the Nasdaq reflects the action of tech stocks, and the Russell 2000 index better shows how small-caps are faring.

There are a variety of other indexes available to show the action of mid-caps, value or growth stocks, or of individual industries. SectorUpdates.com (www.sectorupdates.com) is a good place to find these indexes. Click on Sector Charts to see the complete list.

It's best to avoid buying stocks in a downtrending market unless it belongs to an industry sector showing strength despite the weak overall market.