What is Technical Analysis
Technical analysis is a technique of selecting stocks to buy based on a stocks price and volume action. The key tool that will help technicians make stock investment decisions is a stocks price chart. Every stock, whether it be Apple (AAPL) or Google (GOOG) has a stock chart. This stock chart can present information such as the past price performance of the stock, volume (stock turnover) that took place a given time frame, and many other indicators. Ultimately by evaluating all these indicators on the stock chart, technical analysis can help a trader or investor make inferences about what a stock could do later on.
What Technical Analysis Isn't
In its most pure form, technical analysis is the complete opposite of fundamental analysis. Technicians could care less with the intrinsic value of a business based on metrics like earnings per share, revenue growth, balance sheet analysis, etc. While many times the stocks with the top fundamentals will also have fantastic technical chart patterns, technical analysis is not as concerned with the fundamental side of the equation. A business may have decreasing sales within an extremely competitive environment, but if the stock chart shows a specific pattern, many technical analysts will be looking to purchase the stock to capture any potential upside.
Benefits of Technical Analysis
One of the primary features of technical analysis is that it can provide a great means of risk management. When you buy a stock, the reason you buy it is because you suspect that at some stage in the future it will be worth more than you funded it. According to your time frame (time between when you buy and sell the stock), your profit target for that stock might be different. What you ought to consider before you get into any trade or investment is, "What if I am wrong?" This is when risk management is needed. Using technical analysis as a tool for risk management is an excellent tool for investors and traders of all levels. Trend lines, moving averages, and support/resistance levels are all tools which you can use on a stock chart to help you identify when to sell your stock in case you are wrong.
A moving average such as the 50 day moving average (most common average used) charts a stocks average price over the last 50 days on a chart and helps to recognize the overall trend (up or down) of the stock. A very simple risk management tool that longer term trend traders use is that they'll continue to hold a stock provided that it is above its 50 day moving average (see examples at How to Buy Stocks HQ). This is definitely not a hard fast rule, because there are several pitfalls and nuances of such a strategy, which I will look to elaborate further on in the future. Nevertheless for now, the important thing to understand is the fact that technical analysis supplies a good way for a trader to keep their emotions in balance by letting the stock charts decide if you should buy, sell, or hold.
Disadvantage to Technical Analysis
While you will find basic rules to technical analysis that almost all traders agree upon, just following these rules won't guarantee you make money over the long haul. You will find that because so many others consider themselves technicians, that many times these rules are made to be broken. When everyone is watching the same thing on a stock chart, you can typically expect the opposite to take place even when it goes against conventional wisdom.
Buying Stocks Using Technical Analysis
Typically there are three things on stock chart that every technician searches for when searching for which stocks to buy: 1. Consolidation or basing pattern 2. Low volume pullback 3. High volume breakout. There are tons of numerous basing patterns that technicians look out for, but 2 of the most common are "cup and handle" and "flat base". In simplest terms, these are formations that show up on a chart that can give clues about where a stock could be headed down the road. Low volume pullbacks show that as a stock goes down in price, less individuals are willing to sell there shares and can be a good indication that the stock will continue higher before long. Conversely a high volume breakout implies that there's a huge demand for the stock as many institutions (mutual funds, hedge funds, etc) are attempting to buy up as many shares as is possible because they think the stock is going higher.
Conclusion
This post is simply a basic primer to get you introduced to simple technical analysis. There is a lot more we will delve into in future posts like frustrations I've come across using technical analysis as well as methods on when you should sell your stock for profit or cut your losses when you are wrong. One thing to bear in mind using technical analysis, is that you must know what time frame (how long you typically hold a stock for once you buy it) you are using to invest. If you're a short-term trader (hold for a day), you could possibly only look at 5 minute charts in which each green and red bar on the chart represents 5 minutes. While if you're a intermediate term trader (hold for several weeks to months), you will want to focus on daily charts (each bar represents 1 day), or weekly charts (each bar represents 1 week). Regardless of what time period you decide on, mastering technical analysis takes many years of work, studying, and discipline to become consistently profitable.
Technical analysis is a technique of selecting stocks to buy based on a stocks price and volume action. The key tool that will help technicians make stock investment decisions is a stocks price chart. Every stock, whether it be Apple (AAPL) or Google (GOOG) has a stock chart. This stock chart can present information such as the past price performance of the stock, volume (stock turnover) that took place a given time frame, and many other indicators. Ultimately by evaluating all these indicators on the stock chart, technical analysis can help a trader or investor make inferences about what a stock could do later on.
What Technical Analysis Isn't
In its most pure form, technical analysis is the complete opposite of fundamental analysis. Technicians could care less with the intrinsic value of a business based on metrics like earnings per share, revenue growth, balance sheet analysis, etc. While many times the stocks with the top fundamentals will also have fantastic technical chart patterns, technical analysis is not as concerned with the fundamental side of the equation. A business may have decreasing sales within an extremely competitive environment, but if the stock chart shows a specific pattern, many technical analysts will be looking to purchase the stock to capture any potential upside.
Benefits of Technical Analysis
One of the primary features of technical analysis is that it can provide a great means of risk management. When you buy a stock, the reason you buy it is because you suspect that at some stage in the future it will be worth more than you funded it. According to your time frame (time between when you buy and sell the stock), your profit target for that stock might be different. What you ought to consider before you get into any trade or investment is, "What if I am wrong?" This is when risk management is needed. Using technical analysis as a tool for risk management is an excellent tool for investors and traders of all levels. Trend lines, moving averages, and support/resistance levels are all tools which you can use on a stock chart to help you identify when to sell your stock in case you are wrong.
A moving average such as the 50 day moving average (most common average used) charts a stocks average price over the last 50 days on a chart and helps to recognize the overall trend (up or down) of the stock. A very simple risk management tool that longer term trend traders use is that they'll continue to hold a stock provided that it is above its 50 day moving average (see examples at How to Buy Stocks HQ). This is definitely not a hard fast rule, because there are several pitfalls and nuances of such a strategy, which I will look to elaborate further on in the future. Nevertheless for now, the important thing to understand is the fact that technical analysis supplies a good way for a trader to keep their emotions in balance by letting the stock charts decide if you should buy, sell, or hold.
Disadvantage to Technical Analysis
While you will find basic rules to technical analysis that almost all traders agree upon, just following these rules won't guarantee you make money over the long haul. You will find that because so many others consider themselves technicians, that many times these rules are made to be broken. When everyone is watching the same thing on a stock chart, you can typically expect the opposite to take place even when it goes against conventional wisdom.
Buying Stocks Using Technical Analysis
Typically there are three things on stock chart that every technician searches for when searching for which stocks to buy: 1. Consolidation or basing pattern 2. Low volume pullback 3. High volume breakout. There are tons of numerous basing patterns that technicians look out for, but 2 of the most common are "cup and handle" and "flat base". In simplest terms, these are formations that show up on a chart that can give clues about where a stock could be headed down the road. Low volume pullbacks show that as a stock goes down in price, less individuals are willing to sell there shares and can be a good indication that the stock will continue higher before long. Conversely a high volume breakout implies that there's a huge demand for the stock as many institutions (mutual funds, hedge funds, etc) are attempting to buy up as many shares as is possible because they think the stock is going higher.
Conclusion
This post is simply a basic primer to get you introduced to simple technical analysis. There is a lot more we will delve into in future posts like frustrations I've come across using technical analysis as well as methods on when you should sell your stock for profit or cut your losses when you are wrong. One thing to bear in mind using technical analysis, is that you must know what time frame (how long you typically hold a stock for once you buy it) you are using to invest. If you're a short-term trader (hold for a day), you could possibly only look at 5 minute charts in which each green and red bar on the chart represents 5 minutes. While if you're a intermediate term trader (hold for several weeks to months), you will want to focus on daily charts (each bar represents 1 day), or weekly charts (each bar represents 1 week). Regardless of what time period you decide on, mastering technical analysis takes many years of work, studying, and discipline to become consistently profitable.
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