Introducing Technical Analysis

The basics

Technical analysis (a.k.a. charting) is easier to learn than expected. It represents the trend of the market (a stock or a group of stocks) graphically. If more investors are in the market, a stock or a group of stocks, its trend is up until it changes. We divide the trends into short-term, intermediate-term and long-term.

The chartists usually do not consider fundamentals as they believe they have already been priced in the stock price and some fundamentals are not available to the public. To illustrate, a new drug has been discovered, the stock price of the company jumps initially by insiders and the informed. Its fundamental metrics do not show right away but many are buying to boost up the stock price.

The volume is a confirmation. When the stock moves up or down by 10% with a low volume, the trend is not confirmed.

The trend of the stock price is not straight line in most cases. Hence a trend line is usually drawn to indicate the direction of the stock. Many believe the stocks fluctuate in certain range (i.e. channels) and the chart draws the upper value (the resistance line) and the lower value (the support line).

When the price passes the channel, it is called a breakout. Darvas, one of the oldest and successful chartists, profited from the breakouts of the resistance line and believed the stock is close to the support line of the new channel. Hence it has a long way up.

If it is so simple, there will be no poor folks

It works most of the time, but do not bet all your money on it. For chartists, 51% is great (same for playing Black Jack). Some trends reverse very fast such as the bio drug stocks in 2015. You need to hedge your bets such as placing stop orders. Most do not want to spend their lives in watching the trend from a big screen. Most novices use too many technical indicators and lose to the professionals.

Simple Moving Average

The basic technical indicator is SMA-N. It is the average of the last N trade sessions. When N is 20 (or SMA-20), we classify it as short-term. Similarly, SMA-50 is intermediate-term and SMA-200 is long-term. I prefer 50, 100 and 250. This trend duration is important. For example, you do not want to place long-term bets using SMA-50 uptrend. There are many modifications to SMA that I do not find them better such as giving more weights to recent data. Finviz.com includes this information without charting.

Defining the trend periods is arbitrary. I use SMA-350 to detect market plunges and SMA-100 for stocks. 

Trend is your best friend

Most use TA for trending for short durations. Investors can also use TA to time the entry and exit points for better potential profits. Value investors usually are patient and they do bottom fishing and they search for ‘oversold’ condition using RSI(14).  Again high volume is a confirmation.

Many sites provide charting free of charge such as Yahoo!Finance. Finviz.com provides a lot of technical indicators without charting such as SMA% and RSI(14). It also provides screen searching for stocks that meet your technical analysis criteria.

TA patterns

There are many TA patterns such as Bollinger Bands and MACD. The patterns are based on the stock prices and many times they prove correct predictions especially on stocks with high volumes and high market caps.

Sites for TA

There are many free sites for charts with explanation of the technical indicators. Popular ones include BigCharts.com, SmallCharts.com and Yahoo!Finance. Fidelity includes some unique features such as P/E. 

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