Technical Analysis Techniques


Technical analysis techniques have been used for hundreds of years; back to when markets were first established for people to trade with one another.

But its roots go back even further in time.

Our minds are wired for pattern and trend recognition...it's how our ancestors avoided danger and survived!

In the modern world, we don't have to worry about being eaten by wild animals.

But people still use patterns and trends to make decisions, particularly when it comes to investing.


What is Technical Analysis


Technical analysis is the search for patterns and trends in price.

It is based on an assumption that price movements are related to human behaviors. Since human behavior tends to repeat itself (the phase "creature of habit" comes to mind), patterns and trends in prices can be repetitive.

Not everyone believes price movements are repeatable. In fact, asset allocation was born out of the belief that the movement of stock market prices are completely random.

All technical analysis starts from the same place; plotting price changes over a period of time. Add in the trading volume associated with that price change, and you have the three building blocks that form the base for all technical analysis (price, time, and volume)!


Why Use Technical Analysis


Safe investors use a combination of fundamental and technical research. The fundamental side gives you an internal perspective (i.e. value of a company).

The technical side gives you an external perspective (i.e. the price people are willing to pay).

The external perspective is extremely important if you plan on making money from your investments.

Why?

Because prices can change independently of value. As an extreme example, think about any market crash. Did company values really change that drastically? Probably not.

What changed were the prices at which buyers and sellers were trading.


How to Use Technical Analysis


Generally speaking, you study charts and search for prices that offer buying opportunities (support), and prices that offer selling opportunities (resistance).

Resistance is means a price that acts as a ceiling. Once you reach this price, people will sell shares and the price will fall.

Support is the price that acts as a floor. Once the stock's price reaches this level, people will buy shares and the price will rise.

A trend line is a line drawn between the highs of at least two peaks or the lows of at least two valleys.

Technical analysis techniques range from simple lines of resistance and support, all the way to complex, cyclical theories like Elliot Wave.

Overlays


These indicators are usually plotted on top of the prices on a stock chart. The easiest overlay is a trend line connecting highs or lows, which is used to show upward and downward price trends.

  • Bollinger Bands
    • Uses price volatility to determine whether a stock is overbought or oversold
  • Moving Average Envelopes
  • Parabolic SAR (Stop And Reverse)
    • A "momentum" indicator showing when price trends have a higher-than-normal probability of switching directions
  • Price Channels
    • Lines drawn through price highs and lows, showing the upper and lower boundaries of price movement over a given period of time.

Indicators (Price Based)


Indicators are statistical calculations based changes in price. They are designed to highlight overbought and/or oversold price points, which then tell you when to sell or buy, respectively.

  • Directional Movement Index (DMI)
    • Compares the "strength" of upward and downward price movement
  • MACD (Moving Average Convergence/Divergence)
    • Compares two moving averages
  • Momentum indicator
    • Measures the rate of change in price
  • Relative Strength Index
    • A "momentum" indicator comparing recent gains to recent losses
  • Stochastic Oscillator (Fast / Slow)
    • A timing indicator used to show trend reversals by comparing the current price to price range over a time
  • Ultimate Oscillator
    • A "momentum" indicator that combines short-term, intermediate-term, and long-term moving averages
  • Williams %R
    • A "momentum" indicator comparing a stock's closing price to the high-low price range during a period of time
  • Rate of Change (ROC)
    • The percentage change between the current price and a past price

Indicators (Volume Based)


Indicators are statistical calculations based changes in volume. They are designed to highlight overbought and/or oversold price points based on the number of shares being bought or sold.

  • Accumulation Distribution Line
    • Combines price and volume to show whether money is flowing into or out of a stock
  • Money Flow
  • On Balance Volume (OBV)
    • A "momentum" indicator relating trading volume to price changes
  • Up/Down Ratio
    • A comparison of trading volume between days with rising and falling prices

Indicators (Market Based)


These indicators are statistical calculations usually used to evaluate market averages.

  • Advance Decline Line

Indicators (Fundamental Based)


Fundamental indicators use values from the analysis of a companies financial statements and relate them to a stocks price movements.

  • Price to Earnings Ratio
    • A comparison of the market's view of a stock (price) and the income a company actually generates
  • Rolling Dividend
    • A stock's annual dividend dividend by the current price per share
  • Rolling EPS
    • A company's previous earnings per share added to the future estimated EPS
  • Short Interest
    • A market-sentiment indicator that shows the quantity of shares that investors have sold short
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