Write down the name of 5 stocks on a piece of paper. Pin the paper to the wall and throw a dart at it. Whatever stock the dart lands on – that’s what you invest in… right?
Well… hopefully not.
Stock picking is half luck though – but more importantly – its due diligence. You have to study patterns, charts and historical data, all while taking into consideration what’s happening in the broader markets and the company’s particular industry. Also understand that perception plays into the equations as much as reality.
Now there are 2 schools of analysis that many investors follow to reach their conclusions: Technical and Fundamental Analysis.
Today we’ll discuss technical analysis and see how it can fit into your decision making process – unless you want to stick to throwing darts at a piece of paper – then stop reading.
I come from the school of thought that any company in any industry can be a winner. Using a bottom-up approach to find a strong company using fundamental analysis – then get technical and look for a point where a breakout could occur.
Now stocks move higher for a myriad of reasons: Rumors. Revenue and sales results… anticipation of quarterly data. It can be as simple as passing a line on a chart. Or using historical trends.
So let’s start off at what we can wrap our heads around and take it from there.
What’s technical analysis? Essentially looking at charts, using some different proven indicators to make an assessment as to when a stock will move higher, or lower.
There’s no better testament of the influence that technical analysis has over the investment community than the fact that just about every platform, be it free or paid for, includes some type of interactive chart of some sort.
Go to Finance.yahoo or StockChart.com and you’ll see the countless charting options. Studying charts is the playground for technical analysis geeks. Part math – part science – part luck.
You can spend hours drawing resistance and support levels, each with its own outcome and indication. Tweak it a bit and you can create what you want to believe will happen.
It’s easy to get carried away and have a little bit of over-analysis come into play as well.
Ever happen to you? You’re not alone. So today we’ll cover a couple basics and leave the wild theories and secret formulas to the big investment banks.
Many traders look at the 50 and 200 day SMA for breakouts and trends. The 50 day SMA is typically the bottom line with the top being the 200. These points can also be defined as support and resistance levels.
I suggest you look at a 1yr chart. See how the 2 SMAs are moving – in an upward or downward trend. Then look at where the stock is actually trading. This will give you an idea of where to start…
If you see a pattern develop where every time a stock drops below the 50 day SMA it will continue moving lower to a support point. Conversely when the stock rises back up and moves higher than the 50 day SMA – you’ll see it typically move to a line we can call Residence.
The sweet spot is right there. Find a stock trending slightly lower than their 50 day SMA and about to move higher, then there’s a good chance it could breakout – and if it moves higher above its resistance point (typically their 200 day SMA) then it could be off to the races.
Looking at the Relative Strength Index (RSI) of a stock can give you a good idea as to whether or not a stock is being ‘over-bought’ or ‘over-sold’. Obviously if the stock is overbought then it might not be the best time to invest. Conversely, if the stock is oversold – it could be a good time to buy as it should be relatively cheap. The key is to see it trending from oversold to the middle ground.
When looking at relative strength on a chart you’ll see that the number 50 is the middle ground. 70 and above a stock is overbought. 30 and below a stock is oversold.
Using Simple Moving Averages can help give you an idea as to what a stock has historically done compared to those points. It’s a good indicator of future activity. RSI is great for gauging investor sentiment. Used together you’ll get a good idea of where a stock could be headed.
Regards,
Ethan Warrick
