How to Buy Stocks – Technical Analysis
Friday, March 23rd, 2012What 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 using the intrinsic value of a company based on metrics such as earnings per share, revenue growth, balance sheet analysis, etc. While many times the stocks with the best fundamentals will also have terrific technical chart patterns, technical analysis isn’t as worried about the fundamental side of the equation. A company could have decreasing sales in an extremely competitive environment, however if the stock chart shows a certain pattern, many technical analysts will be looking to purchase the stock to capture any potential upside.
Benefits of Technical Analysis
One of the primary benefits of technical analysis is that it can provide a fantastic method of risk management. When you buy a stock, the reason you purchase it is because you feel that at some point in the future it will be worth a lot more than you purchased it for. According to your time frame (time between when you buy and sell the stock), your profit target for the stock may be different. What you should ask yourself prior to into any trade or investment is, “What if I am wrong?” This is where risk management is needed. Using technical analysis as a tool for risk management is a great tool for investors and traders of all levels. Trend lines, moving averages, and support/resistance levels are common tools which you can use on a stock chart to help you identify when to sell your stock should you be wrong.
A moving average like the 50 day moving average (most typical average used) charts a stocks average price over the last 50 days on a chart and helps to spot the general trend (up or down) of the stock. A simple risk management tool that longer term trend traders use is that they’ll continue to hold a stock providing it is above its 50 day moving average (see examples at How to Buy Stocks HQ). This is definitely not a hard fast rule, as there are several pitfalls and nuances of this type of 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 offers a good way for a trader to keep their emotions under control by letting the stock charts determine whether you should buy, sell, or hold.
Disadvantage to Technical Analysis
While you will find basic rules to technical analysis that most traders agree upon, just following these rules won’t guarantee you make money over the long haul. You will find that because so many other people 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 though it is going 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.
To see free chart pattern examples and learn more about technical analysis, you should definitely check out How to Buy Stocks Headquarters