The net price rule

The net price rule states that you should trade only on the side of the net price. If you want to go long a stock, the net price should be positive. If you want to go short a stock, the net price should be negative. If the net price is positive, you should not be short; if it is negative, you should not be long.

The net price rule should be used for a stock, the stock's underlying sector, and the broader market. If you are contemplating trading an Internet stock, the first thing to look at is the net price of the stock itself. If it is net price positive, trade from the long side but not the short side. If the net price is negative, trade from the short side but not the long side.

After looking at the net price of the individual stock, look at the stock's underlying sector. If you are trading an Internet stock, you might look at the Internet Index (DOT). If the DOT is net positive on the day, trade from the long side but not the short side. If the DOT is net negative on the day, trade from the short side but not the long side.

After looking at the net price of the DOT, look at what the broader market as a whole is doing. If the NDX 100 is net positive on the day, trade from the long side but not the short side. If it is net negative on the day, trade from the short side but not the long side.

You will not always receive mutual net price confirmation between a stock, its sector, and the broader market. The odds of being on the right side of the trend increase when all three are in your favor. If all three are not in your favor, use the net price of the stock and its sector as the two guidelines to follow.

The net price of a stock or sector indicates which side the market consensus is on. A positive net price votes in favor of the bulls, while a negative net price votes in favor of the bears. The net price reflects the market's judgment as to whether this stock should be higher or lower today than yesterday's closing price.

The reason a stock is trading higher or lower than the previous day's close is irrelevant. Traders can get caught fighting a trend or bottom fishing when they analyze and think too much. Once a rigid opinion is formed, it is hard to admit defeat because your ego is involved. This is even more evident when you announce your opinion to others. Traders make up all sorts of rationalizations to avoid looking "stupid" or wrong in front of other people.

The net price is the quickest measurement of the market's opinion of how a stock should trade today compared to yesterday. When you listen to the market's opinion, your trading will take place along the path of least resistance. The direction of net price is a crucial piece of information that does the thinking for you.

One of the benefits of trading on the side of the net price is that it will prevent you from fighting the trend. If you isolate a trade for the long side and you're itching to trade it, a negative net price will prevent you from buying it. The negative net price tells you that the gravitational force is not pulling in your direction.

Nonprofessional traders often go long in stocks that are net down on the day because they think the price is low. People love to get a bargain, especially when they are eyeing a piece of merchandise that was more expensive a few days before, or even a few hours before. When traders buy stocks that are down on the day because the stock looks "cheap," they get what they pay for—something that is not worth very much.

Remember, it takes more energy and power for an object in motion to stop and reverse course than it does for it to continue along its path of motion. Always remember that, as a day trader, you should buy or sell stocks that are moving in your direction, not against you. Prices do reverse course intraday; there is no question about that. Big price reversals are more the exception than the rule, however. When prices do reverse course, you will still have ample opportunity to profit after the net price has turned in your direction. Price reversals normally provide excellent opportunities to climb on board after the net price turns in your favor, because large price reversals have momentum on their side, and that normally continues.

Here is a summary of the time periods to examine along with the most favorable conditions for catching a trend. You will not always be afforded the luxury of locating an idea when all the trend factors point in your direction. When you do find ideas that have the maximum trend signals pointing in your favor, then your conviction should be at the maximum. When all the factors are not in your favor but you still like an idea, the more of the signals that are in your favor, the better.

Weekly

The first chart to look at is the weekly chart. The strongest measure of a weekly uptrend includes price action with these characteristics:

a. Price above the previous week's high.

b. Price above the weekly opening price.

c. Price above the 8-period moving average.

d. Price above the previous week's closing price.

Daily

After determining the strength of the weekly trend, the next trend to look at is the daily one. The strongest measures of a daily uptrend are similar to those for a weekly trend:

a. Price above the previous session's high.

b. Price above the previous session's close.

c. Price above the 8-period moving average.

d. Price above the opening price.

Intraday

Intraday trends are the most immediate signals for short-term price action. These trends provide the first clues for entry or exit. The distinction between an intraday trend and the daily trend is the intraday price action. The intraday moving average provides a quick way to assess which way the wind is blowing. If a sector is trading above its 8-period moving average on 60-minute and 15-minute intraday charts, the short-term trading trend is positive. The last price should also be above the opening price and the previous session's close:

a. Price above the intraday 8-period moving average.

Remember that your objective as a day trader is not to catch the entire move. Attempting to catch an entire move is unrealistic and the by-product of faulty guesswork and wishful thinking. As a day trader, you are best served when you resist the urge to being completely right, and instead stay focused on trading with the middle of the trend. The probabilities for catching a trend increase with the number of signals that are in your favor.

One reason it is important to stay focused on catching the middle of the trend is that it is the easiest part to catch. It is the easiest part to catch because prices in motion tend to stay in motion. The objective tools you can utilize to identify a trend in motion include the daily and the intraday short-term moving averages, the opening price signal, the net price, and the previous sessions high and low price. When all three factors point in your direction, then you can act decisively.

FUNDAMENTALS

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  • Stefanie
    What is the net price rule?
    7 years ago

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