Interested in adding technical analysis to your fundamental approach to stock-picking and trading?
The following program of lessons and assignments on TheStreet.com will help you get "chart smart" -- fast.
Support & Resistance
Market watchers often talk about a stock meeting support or resistance. They're referring to lines drawn on a chart -- sometimes trend lines, sometimes not -- where price has established a high or low or, in some cases, has merely spent a lot of time trading around.
Support is a line below the stock's current price that serves as a floor from which price can bounce and go higher or, at least, stop going lower. Resistance, therefore, is a level that stands in the way of a stock's continued rise. In both cases, the more times a stock's price has touched a line without going through it, the stronger the line becomes.
If the big
institutional investors and players such as Warren Buffett, Carl Icahn and George Soros (who have billions of dollars to invest, huge research budgets) are buying and selling a stock, then that activity will be reflected in the stock chart -- the graph of the stock's historical price over time.
If a stock's chart is showing that an institutional feeding frenzy is taking place, we might want to join the feast.
In this assignment, you will learn how to use the most common technical tool: the moving average.
A Look at Microsoft's Chart
Let's look at
one-year line chart for 2007:
Microsoft zigged and zagged during the year, trading in about an 11-point range, between $26 and $37. Clearly there were many times when you could have reaped a short term profit,
you could have figured out how to buy at one price and sell a higher one.
The Bollinger Bands give you an idea of the stock's price support and resistance levels, as well as how wide a price range the stock is expected to trade in. If the difference between the upper and lower band is expanding, the stock is breaking out of its
trading range (either high or low).
Candle charts, also known as Japanese candlestick charts, have an old and venerated history, particularly in the Far East. According to a Japanese urban legend, candlestick charts were invented by Homma Munehisa, an 18th century rice merchant who traded in the Ojima Rice Market in Osaka. Legend has it that he was successful in 100 out of 100 trades.
With such a track record, candle charts developed quite a following, particularly among futures traders. Candle charts are now so widely used by stock traders and investors alike that most charting software can display them. So what's the big deal with these candlesticks?
Both the commonly used open-high-low-close (OHLC) charts and candlestick charts display the same price data. However, candle charts give you a much clearer picture of the stock's price action.
One of the most common problems that a stock technician faces is that not all buy or sell signals are genuine. A signal, such as a bullish candle on a one-minute candle chart, a stock price crossing its 20-day moving average, or the price touching the upper Bollinger Band, may be only a temporary blip. The very next minute, the price might reverse sharply. Placing a buy order relying on one indicator over a short time frame -- a "false positive" -- could result in a big loss. Enter the "MACD."
Technicians use the MACD (Moving Average Convergence/Divergence) either to confirm the potential buy or sell decision (a "convergence") or to detect a false positive (a "divergence").
With its roots in the Greek language, the word stochastic means to "to guess" or "to aim." The term's application in the stock world is to come up with a percentage -- 0% for
to 100% for
-- that a trend will continue.
In addition to the moving average, Bollinger Bands, and stochastic oscillators, another frequently used indicator is the Relative Strength Index, or RSI.
As with the stochastic oscillators, the RSI calculation considers a statistic -- for the RSI, it's the stock's
closing price over a period of time -- and transforms the statistic into a percentage (from 0% to 100%), which measures the strength of the price trend, from weakest to strongest.
To learn more about technical analysis from successful Wall Street pros, check out RealMoney.
This article was written by a staff member of TheStreet.com.