Technical analysis is the study of price and volume data to identify trading opportunities. While fundamental analysis tells you what to buy, technical analysis helps you decide when to buy and sell. Here are the essential concepts every investor should understand.
Support and Resistance
Support is a price level where buying pressure historically prevents further decline. Resistance is a price level where selling pressure prevents further advance. These levels are identified by looking at where prices have previously reversed. When support breaks, it often becomes resistance, and vice versa.
Moving Averages
Moving averages smooth price data to identify trends. The 50-day moving average captures intermediate trends, while the 200-day captures long-term trends. The golden cross (50-day crossing above 200-day) signals bullish momentum, while the death cross (50-day crossing below) signals bearish momentum.
Chart Patterns
Common bullish patterns include cup-and-handle, ascending triangle, and double bottom formations. Bearish patterns include head-and-shoulders, descending triangle, and double top formations. These patterns reflect the psychology of market participants and often precede significant price moves.
Volume Analysis
Volume confirms price movements. A price advance on high volume is more significant than one on low volume. Volume spikes often occur at market turning points. The relationship between price and volume provides crucial context for interpreting chart patterns.
Key Indicators
RSI (Relative Strength Index) measures momentum, with readings above 70 indicating overbought conditions and below 30 indicating oversold. MACD identifies trend changes through moving average convergence and divergence. Bollinger Bands measure volatility and identify potential reversal points.
Combining Technical and Fundamental Analysis
The most effective approach combines both disciplines. Use fundamental analysis to identify quality stocks, and technical analysis to time your entries and exits. This combined approach maximizes your edge by ensuring you buy good companies at attractive technical levels.
Conclusion
Technical analysis is a valuable tool in any investor's toolkit. While it is not predictive with certainty, it provides a framework for making better timing decisions. Start with the basics covered here, practice with paper trading, and gradually incorporate technical analysis into your investment process.
Stock News Plus Editorial
Expert financial analysis and market insights from the Stock News Plus editorial team.