Some of you have told us - "before I make judicious use of SaralStocks to grow my wealth in the long-term, i need to understand better the mechanisms of technical analysis & important* indicators".
*this is noteworthy because with more than 80 technical indicators, you can get lost in the maze but you need to be able to focus on the essential ones.
So, here's a quick Tech Analysis 101 (with text borrowed from Investopedia)
Technical analysis is a method of evaluating any securities, stocks included, that involves a statistical analysis of market activity, such as price and volume. Technical analysts use charts, technical indicators and other tools to identify trends or patterns that can be used as a basis for investment decisions.
The use of historical price and volume data is what distinguishes technical analysis from fundamental. Technical analysis does not concern itself with a stock’s valuation – the only thing that matters are past trading data and what information the data might provide about future price movements.
Technical analysis and fundamental analysis are often seen as opposing approaches to analyzing securities, but many investors have experienced success by combining the two techniques. For example, an investor may use fundamental analysis to identify an undervalued stock and use technical analysis to find a specific entry and exit point for the position. Often times, this combination works best when a security is severely oversold and entering the position too early could prove costly.
Alternatively, some primarily technical traders will look at fundamentals to support their trade. For example, a trader may be eyeing a breakout near an earnings report and look at the fundamentals to get an idea of whether the stock is likely to beat earnings.
The idea of mixing technical and fundamental analysis isn’t always well-received by the most devoted groups in each school, but there are certainly benefits to at least understanding both schools of thought.
Prices almost never move in straight lines. Rather, prices tend to move in a series of highs and lows over time. The overall direction of these highs and lows constitutes a trend. An uptrend is classified as a series of higher highs and higher lows, while a downtrend consists of lower lows and lower highs.
Sideways or horizontal trends occur when there is little movement up or down in the peaks and troughs of a trend. If you want to get technical, you might even say that a sideways trend is actually the absence of any well-defined trend in either direction.
Volume is the number of shares that trade over a given period – usually a day. It's often expressed as a bar chart directly below the price chart with the bars height illustrating how many shares have traded per period. Volume charts can also be analyzed to show trends of increasing or decreasing volume over time.
Volume can be used to confirm trends and chart patterns. The strength of any given price movement is measured primarily by volume. In fact, a 50% jump in a stock price may not even be relevant if it occurs on very low volume – just look at penny stocks (which we at SaralStocks call 'garbage' stocks).
Another example, assume a stock jumps 5% in a single trading day after being in a long-term downtrend. Is this a reversal of the trend? Depends on if there was a substantial amount of volume behind the move. If the volume was below average, the move was likely a flash in the pan, and the downtrend will resume. But, if the volume was significantly higher than average, you definitely need to sit up and take notice (and place the stock on your SaralStocks watchlist).
Charts are graphical representations of a series of prices over time. For example, a chart might show a stock’s price movement over a one-year period where each point represents an individual day’s closing price. Typically, price is on the Y-axis and time on the X-axis.
There are several factors that investors should be aware of when looking at a chart, since these can affect the information that is provided. They include the time scale, price scale, and price point properties used to create charts.
The time scale refers to the range of dates that appear at the bottom of the chart, which can vary from seconds to decades. The most frequently used time scales are intraday (not relevant to the ideal SaralStocks user), daily (again not very relevant), weekly, monthly, quarterly, and yearly.
Chart patterns can be difficult to read given the volatility in price movements. Moving averages can help smooth out these erratic movements by removing short-term fluctuations and make trends easier to spot. Since they take the average of past price movements, moving averages are better for accurately reading past price movements rather than predicting future movements.
The most widely used moving averages is Simple Moving Averages (SMA), which takes the sum of all of the past closing prices over a time period and divides the result by the total number of prices used in the calculation. For example, a 10-day simple moving average takes the last ten closing prices and divides them by ten.
Indicators (read more here) represent a statistical approach to technical analysis as opposed to subjective. By looking at money flow, trends, volatility, and momentum, they provide a secondary measure to actual price movements and help investors confirm the quality of chart patterns or form their own buy or sell signals.