Technical Analysis: Basics Factors

Technical analysis is a method of analyzing a stock or company solely on statistics generated by market activity. This can include volume, historical prices, etc. Using these charts and patterns many can suggest and predict future activity. However, plain and simple, technical analysis is only based on three1-stock-market assumptions.

1. The market discounts everything.

2. Prices move in trends

3. History always tends to repeat itself.

The Market Discounts Everything  – One major critic about technical analysis is the fact it only takes into consideration price movement. Analysts looking for technical indicators ignore fundamental factors. The way they get around is by the theory that at any given time, a stocks share price will reflect everything that could possibly affect a company. This includes the effects brought on by fundamental factors. Since these factors are already priced into the stock, they believe all that matters is the analysis of price movement, which basically is the supply and demand of a stock.

Prices Move in Trends – This basically means that the price movements will follow similar patterns. It all comes down to assumption and the analyst assumes that the trends will follow on a similar pattern.

History Always Tend to Repeat Itself – The market repeats itself in its patterns of price movements. Analyzing charts for the past 100 years you can see everything follows a similar pattern so a could technical analyst will be able to read when the next trend is coming.

Types of Trends

SP500-30Year-Monthly-ChartThere are three types of trends: Long-Term Trends, Medium-Term Trends, and Short-Term Trends.

The Long-term trend is over a year, the Medium-term trend is one to three months, and short-term is less than a month. If you are a long-term investor all you should worry about is the Long-term trend. If you look its a recipocal cycle for the stock to fluctuate with ups and downs, however long-term companies usually all go up as seen by the chart to the right. In this case the Super Trend is the Long Trend, the Dot com Bust is the medium trend and the small falls and gains in between are the small trend. Thats why long-term investors don’t look at their investments on a daily basis as due to fluctuations it doesn’t make sense. On the contrary if you trade regularly the Medium-term trend might be more critical. Remember the two most important sayings on trends: “the trend is your friend” and “don’t buck the trend.”

Support and Resistance Levels

Support and Resistance can often be characterized as the on-going fight between the bulls and the bears or the struggle between supply and demand. This graph will help illustrate the difference: Support is the price level for which a stock or the market in general falls. Resistance is the price level it surpasses.

support-resistance

Are you following along? Well read carefully as support and resistance levels are crucial factors involved within the markets. Simply they are the price levels at what traders/investors will buy or sell a stock at. When analyzing support and resistance price levels, round numbers come into play throughout a large amount of charts. Round numbers represent physiological turning points for a stock and become the price levels in which a stock plays off. Often traders/investors will purchase a stock at a price level that they don’t believe it will fall under. For example, Google support level could be $400 where whenever it reaches near that price level, investors buy large quantities. On the other hand, Google could have a resistance level of $500 where investors don’t believe it will continue to go up much further therefore selling off. So now that you know about the basics of support and resistance levels, lets analyze why it’s an important factor.

Support and resistance analysis is crucial for traders as if you can identify a important level of resistance that over time has never been broken you will most likely consider profit taking when it reaches near that level the next time as you believe it is unlikely the shares will exceed that level. They go side by side with trends, as normally a trend will conform to its support and resistance levels. One key tip to know when trading near support and resistance levels is never to place your order on the exact price. Due to increased volatility, when a stock price reaches this level there tend to be a high level of trading volume therefore you will most likely miss out. Therefore place your order a couple points above or under and all will be good.

Moving Averages

When analyzing the moving averages there are two main ones that should be looked at, the 50-Day moving average and the 200-Day moving average. For the 50-Day moving average it is usually considered that if it is below the 200-Day moving average it is on a downtrend and if it above it is on an uptrend. This can also be considered the Golden Cross where if viewing a chart you analyze the 50-day and 200-day averages you should see them cross and depending on which way the 50-day average is moving it will tell you whether or not the stock is heading up or down.

golden cross S&P500 June 2009

(The green arrow here shows the Golden Cross where the 50-Day Moving Average in Blue crosses over the 200-Day Moving Average. On the contrary this also shows the Death Cross which is the complete opposite. This can be seen by the Red arrow at the top and as a result markets collapsed)