Investing Basics: Technical Analysis
I’m planning to release a series of blogs about investing basics since my inboxes on various social media accounts have been flooded with questions regarding investing vs trading, what is technical analysis, what is fundamental analysis, etc. One of my goals of the New Year is to help at least 1,000 people with their personal finances since so few seem to even grasp the basic concepts. As many of you may have noticed, I have intentionally begun posting about personal finance to trigger greater discussions about the topic.
This first blog is about technical analysis, since this type of analysis is not limited to just stocks, but could be used to analyze currencies, even cryptocurrencies, and commodities. Cryptocurrencies have been a hot topic recently and therefore I want to make an informed investor out of you so you STOP losing money!
Technical analysis is a strategy an investor may use to examine an investment’s chart in an attempt to project its future performance. Some investors may use technical analysis to identify when to enter (BUY) or exit (SELL) an investment position. When performing technical analysis, investors can use a variety of techniques and tools to analyze a chart. In this blog, I plan to lay out a few of the basic concepts including trend, support and resistance, price patterns and technical indicators.
Trend is the direction a stock’s price is moving. There are three kinds of trends: up, which is a series of higher highs and higher lows; down, which is a series of lower highs and lower lows; and sideways, which has roughly equal highs and lows. Some investors determine a stock’s trend by identifying the direction of the highs and lows. Trend may be important because many investors believe that a stock will generally continue in the same direction it has been traveling. These investors would expect that an investment with a strong uptrend would continue to rise while one with a strong downtrend would continue to fall. Some investors draw lines to identify the trend. Some investors connect these lines to identify highs and lows, which are termed support and resistance levels.
Support and resistance are price levels that an investment has had trouble breaking through. If a stock breaks through support or resistance, it could be a signal to enter or exit. Suppose a stock breaks through resistance, which is a level the stock has repeatedly pulled back from in the past. Because it broke through resistance, an investor may believe there is a good chance the stock will continue to rise. So, broken resistance may be a good time to enter. On the other hand, if the stock fell past support levels, it may continue to fall. Breaking support is generally accepted as a time to exit (SELL) out of a position. After connecting support and resistance levels, an investment’s price movement may resemble a shape. These shapes are called price patterns.
Price patterns are built on support and resistance, which allows investors to make more precise expectations and therefore determine better entry and exit positions. There are countless examples of price patterns. A simple Google search could find you several examples. Not all investors exclusively use price patterns. Some investors may use technical indicators.
Technical indicators are graphical representations of chart data. Each indicator displays chart data like price and volume in a unique way. This gives investors a different perspective to analyze an investment’s performance. Because technical indicators are created using formulas and data, they may give investors a more objective way to examine an investment’s performance. A common technical indicator is a moving average line. This indicator averages the investment’s price over a period of time and plots it as a line, which can help determine the overall trend. Moving averages can be calculated for any period of time but the most common is 50 days.
Not sure what a moving average could tell you about a stock? Imagine a stock’s price crosses above its 50-day moving average. This would indicate that the stock is out-performing its recent history. This could be a bullish, entry signal. Similarly, if a stock begins to fall and dips below its 50-day moving average, it could be an exit signal. Moving average lines are only one of many technical indicators.
One thing to keep in mind is that technical analysis can help you identify potential entry and exit points but offers no guarantee of success. There is no proven way to predict the future with any investments, aside from an investment in yourself.
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