I had never heard of technical analysis until I tried my hand at futures trading. Like most new traders my plan was to buy low and sell high, which is still the best way to buy and sell stocks. The problems start when we try and figure out what is low and what is high, that’s where technical analysis comes in.
There are basically two ways to analyze a stock, one way is fundamental analysis. This type of analysis is conducted by analyzing a company’s financial condition, are they profitable, are their products in demand, or how many sales have they made. This is a very simplistic view and will be explored in another article.
The second way to analyze a stock is by technical analysis. This widely used approach employs charts depicting price charts (daily or weekly), and trading volumes. Each price chart will show the opening price, the daily range and the closing price of a particular stock. Pure Technicians do not involve themselves with fundamental analysis. Technical analysis uses chart patterns to forecast future price movements. Fundamentalists also can use technical charts to determine entry and exit points where stocks are extended or have retraced a big price move and should commence a new up-leg.
Investment time periods vary from the day (day trading), to short term, to intermediate, to long term. Short term normally implies days to weeks, intermediate implies weeks to months, while long term means months to years.
Moving Averages suggest the smooth trends in the stock most often used by technical investors based on time horizon. First, let's define trendlines. An uptrend is a series of higher highs and higher lows. An up-trend is drawn underneath the beginning low and the lowest low of an up-move. A downtrend is a series of lower highs and lower lows. A downtrend line is drawn from the initial high to next highest high of the downtrend.
Now, let's define support and resistance. Support is an area of prior purchases which acts as a source of demand for the stock on the way down. Resistance is an overhead source of supply of stock to sell triggered by an area of prior purchases. Unsophisticated investors will not sell their losers, they will wait until the price returns to their entry level so that they can end the pain by selling at a breakeven. Likewise unsophisticated investors who at a lower level and saw the stock run up significantly only to return to their purchase are likely to buy at their prior entry level.
To keep it in its simplest form technical analysis uses Trends, Moving Averages, Support and Resistance levels to enter a trade as well as exit a trade. These technical indicators can be very useful in developing a trading system, that being said I want to issue a word of caution, I’ve been trading in one shape or form for the last 15 years and still learn every day.
My advice to you is read, study, learn then practice. There are many fine books out there on Technical Analysis, don’t be afraid to buy one or two and learn as much as you can from them. A good book may cost you $50….A bad trade $500.
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Jim Banks has over 15 years investing experience investing in everything from real estate to commodity futures and is a frequent contributor to www.profit-mountain.com
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