If you want to figure out how to invest in the stock market, you have to learn the technical analysis of stocks. Often referred to as simply “technicals,” technical analysis forms the foundation of how stock prices change over time.
The word “technical” shouldn’t scare you off. While it does require you to understand basic math and charting, you’ll find that computer programs help you do most of the heavy lifting. Trading platforms, including those associated with some brokerage accounts, provide you with all the tools you need.
However, interpreting the technical analysis of stocks is an art, and everyone develops his or her own methodology. Read on for an introduction to technicals for beginners.
1. What Is Technical Analysis of Stocks?
At its most basic, the technical analysis of stocks refers to the observation and interpretation of price action. In other words, how and when does a stock’s price change?
As you learn how to invest in the stock market, you’ll develop a better sense of price momentum. Often, stock price action starts slow, then begins to build as more traders or investors get involved.
Price action can move up, down, or sideways. If the stock trends sideways, maintaining its price within a few pennies, it doesn’t have much potential unless there’s a catalyst (which I’ll cover below). However, when there are significant upswings and downswings, there’s the potential for profit.
The technical analysis of stocks requires you to predict how the price action will change over a given time period. For instance, you might decide that Stock ABC will go from $10 per share to $15 per share in the next seven days. Based on that prediction, you buy at $10 and hope to sell at $15, netting a profit of $5 per share.
What Are Stock Charts?
Technical analysis depends on stock charts. A chart illustrates price action over a period of time. Time moves along the Y-axis, while the X-axis shows the stock’s price movement.
During the technical analysis of stocks, you’re looking for patterns, but I’ll go into that in more depth below. For now, look at lots of stock charts. Using a trading platform, such as StocksToTrade, you can set up your charts however you want.
For instance, you might want to look at Stock XYZ over the last 15 minutes. You can adjust your parameters to view just that time period. A day trader is more concerned with price action over a brief period, while a swing trader or investor wants to see price action over a longer period of time.
Types of Stock Charts
The most common types of stock charts include line charts, bar charts, and candlestick charts. The first two are probably pretty familiar, but candlestick charts are more complicated, while yielding more information.
A candlestick chart features a series of vertical rectangles (the candles) called real bodies. They represent a full day of trading. The upper line and lower line represent the high and low for the day as well as the open and close prices.
The “wicks,” which are the lines above and below the rectangles, are called the upper and lower shadows. You can track them over whatever period you like for the technical analysis of stocks.
What Are Moving Averages?
Averages can help you better understand price movement. For instance, the simple moving average describes the average price of a stock or other security over a given time frame.
Stocks tend to move between two points — resistance and support. Resistance is the highest price the stock reaches, while support is the lowest. If a stock “breaks out,” it rises above resistance. A breakdown means that the stock price cracked support.
For simplicity’s sake, say a stock moves from $10 per share to $20 per share in a straight upswing within eight hours. The moving average is $15 per share, calculated by adding the low and the high, then dividing by two.
Moving averages are useful in the technical analysis of stocks because you want to know when the price action changes significantly. For instance, if you’re screening for stocks in a top-down strategy, you’re looking for stocks that broke out from a consistent moving average.
How Is Future Price Action Predicted?
Traders work on entry and exit points. The entry is when you buy shares in stock (or borrow and sell in a short), while the exit point is when you sell. Ideally, you want to buy stock at the lowest possible price and sell it at the highest.
But how do you predict the price action?
Historical data can tell you what you need to know. Investors and traders look at historical price action to predict how the stock price will move in the future. For instance, if a stock has broken resistance after a 200-day consistent moving average, you might want to buy. It indicates an upswing.
As you practice and learn how to invest in the stock market, you’ll develop your own buying and selling signals. Based on your risk tolerance, you’ll know whether you have the confidence to buy and when you want to exit a trade.
What Are Volume and Volatility?
In the technical analysis of stocks, two signals you want to watch for are volume and volatility.
Volume tells you how many shares of a given stock are traded on a given day. High volume indicates lots of investor interest, which means there will be plenty of shares in play. You want that because, if you need to exit a trade quickly, you need buyers who are willing to pick up your shares. Similarly, if you see a great opportunity, you want to be able to buy enough shares (hold a large position) to maximize profit.
Volatility indicates lots of price action. Instead of the stock price moving by a few pennies at a time, it’s swinging between wider price points. Volatility also results in breaking resistance or cracking support.
When you’re learning the technical analysis of stocks, you need volume and volatility to execute profitable trades. Both give you more information to work with.
A combination of high volume and high volatility can create an amazing opportunity for investors. You know that lots of shares are active on the market, which means buyers and sellers exist in abundance. Plus, the volatility gives you a chance to buy in at a low point and ride the trade until you’re ready to exit at a high.
Just remember that you can’t always ride the whole trade. Mitigate your risk by selling conservatively. For instance, if you think a stock will hit $20 per share, you might sell at $18 after entering the trade at $12. That way, you know you’re taking home profits, but you’re not risking a sudden drop in price that could result in a loss.
What Are Chart Patterns?
A chart pattern is simply a consistent price movement that repeats over time and with many different types of stocks. In a dip buy, for instance, you’re looking for a stock with lots of price action that consistently dips low in price followed by an upswing. When you buy on the dip, you’re betting you can make money on the upswing.
Thousands of chart patterns exist. Some are known to everyone, while others are developed by individual traders. I have lots of chart patterns I look for when executing trades and making recommendations.
Technical Analysis Versus Fundamental Analysis
The technical analysis of stocks uses simple math to understand price movement. However, it doesn’t exist by itself. Outside factors influence price action.
The fundamental analysis adds in outside information, such as a company’s financial statements or recent news about the business. I mentioned a catalyst earlier. In many cases, the price action you see in stock charts is precipitated by an event.
Let’s say a company announces a new patent approval that will completely shake up its market share. You’ll often see a corresponding upswing in the stock price because of sentiment toward the stock changes. That’s a catalyst.
Do you need to learn the technical analysis of stocks? Probably. A more informed trader can make smarter plays and predict how a stock will move in the future.
However, it takes time to learn how to invest in the stock market. If you’re interested in learning what stocks to buy now, sign up for my publications. I’ll send you profit alerts and tons of other useful information so you can jump into the stock market immediately and begin making money.