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I consider index analysis as one of the most important element in any trading system. A trader should know the general market trend and only index analysis can help with this. I would say there are 2 main points in the index analysis that should be used for stock trading:
- Analyze DJI and S&P 500 indexes to see the general market trend – you do not want to trade against the general market trend, especially if you mid- or long-term trader. If based on the S&P 500 and DJI technical analysis you may define whether the economy is in the recession or on the rise, then you have to build your investment strategy in accordance to this. You do not want to see your pension funds, other long-term and mid-term investments in the long position if the market is in the recession. At the same time it would be wrong to stay in cash if you see the stock market in recovery and up-trend.
- Analyze the index your stock belongs to. If you trade stock of the of the internet company and this stock is covered by the Nasdaq Internet index I think it would be logical to take a look at this index to see the general tendency of all internet publicly traded companies. If you trade stock of the financial company, you may want to take a look on the S&P 500 Financial, Nasdaq 100 Financial or other financial indexes. It could be useful to know what is going on in the industry your stock belongs to.
In general there are only two rules based on the index technical analysis recommended when you trade stocks:
- It could be safer to stay in cash when result of the index technical analysis contradict to the results of your stock technical analysis stock;
- It could be recommended considering opening a trade when signal based on the stock technical analysis goes along with results of the index technical analysis.
By embedding elements of the index technical analysis into a stock trading system you may substantially reduce the number of trades, however I would consider it more conservative trading.
