Technical
Analysis - brief re-cap
The usefulness of
techniical analysis is summarised in the statement at the top of this
page - that price charts summarise the opinions (and emotions) of the
market participants. Every chart tells a story, and it can pay to
understand the stories in the price charts.
As a sub-topic of
technical analysis, the huge variety of
technical analysis indicators can help give us more clues about what's
actually happening in the market, and they can give clear cut buy and
sell signals to help with trading and investing decisions.
For more of an
introduction into technical analysis, and why and how we can use it,
see the
Technical Analysis web page.
Quick indicator sample - the Moving Average
The
simplest chart
indicator,
with which many people might be familiar, is the Moving
Average. A sample
of this is shown in the sample chart below. This is a monthly candlestick
chart
of ACR (Acrux Ltd) showing a bottoming of the price in late 2008 and
early 2009,
followed by a rising trend through 2009-2011 (a rising trend, by
definition, is a series of higher peaks and higher troughs - read more about
trends). The blue curve on the sample chart below is the
14-month Simple Moving Average (SMA). See more
about the humble Moving Average.
Why use an indicator? How can they be useful?
Firstly,
it is worth re-stating that the price charts summarise the opinions
of the market participants regarding so-called fair
value
for the share price. The price charts can tell us a story about what
“Mister Market” has
been
thinking. It pays to understand the stories in the price charts - this
is technical
analysis. The more insight we can
gain into the share price history, the more
we can understand the opinions of the market participants, and
the underlying balance of supply and demand of the shares. And
this
can help give us greater confidence about the more likely scenarios
for future price movements.
Don’t
forget that we are not trying to
predict future share prices. We are trying to anticipate
the likely future movements
so that when a price
move
happens, we won’t be surprised by the move, and
we might be able to take advantage of the move (even before it
happens).
It
can be very useful to be able to interpret a technical analysis
indicator, for the following reasons:
-
An
indicator can give a greater insight into what has been happening
with the share price, and therefore a greater understanding of the
opinions of the market participants. For example, a repeated pause
in a trend at a particular price level, or an increasing tendency to
move up faster or slower (or downwards). (eg. Momentum indicator).
-
An
indicator can help to identify a price
trend (uptrend or downtrend), and to quantify the strength or nature of
the trend — is it strong or weak? is it likely to last or not? (eg. ADX.)
-
An
indicator can help us understand the strength of a move in a particular
direction, especially if the volume is factored into the indicator (eg. Money Flow).
-
An
indicator can help us understand if the share price has moved further
in one direction than it normally would under normal share trading
activity (eg. rising momentum, or a volatility indicator like Bollinger Bands). Greater price movements can
hint that someone knows something, or that there is a general swell of
opinion that is tending to move the share price.
-
An
indicator can help us understand if the share price is over-sold, and
that a turn-around to the upside might be likely. And conversely, if the share price is
over-bought and that a turn-around to the downside might be likely. (eg. RSI, Stochastic).
-
An
indicator, or a combination of two indicators, can be used to help
provide a buy or sell signal or trigger for a
potential stock purchase, or for an exit. For example, two different
moving averages (plotted together on the price chart) can provide
signals.
Indicator
categories
Technical
analysis chart
indicators
tend
to be
categorised under four
major headings: trend, volatility, momentum and volume. These different categories tend
to
give different perspectives into the share price movements by
looking at the different characteristics of the price movements.
Samples of some of the indicators in each of the four categories are
indicated below.
If
you want to use several indicators to assist you with a trading or
investment decision,
it is important to use indicators from each of these four groups. If
you
use two or three trend
indicators,
which might
all
give a similar signal, then you are missing out on the clues that
indicators in the other groups could give. In some circumstances,
you will find that indicators in each of these groups might conflict
(ie. some might give a buy signal, while the others do not). This is
for good reason. But when different indicator types concur, the
signal might be more reliable.
One
thing to watch with indicators is that some tend to be lagging
indicators, while only some are leading
indicators. The lagging indicators basically move after the price
action, and confirm a price movement, whereas the leading indicators
change before the price changes.
Where
to from here?
What
next? How to go forward?
For
those who can see the benefits of technical analysis indicators, and
who want to learn more, there is a challenge — which ones to
use? There
are many indicators available, and
for various reasons there are more indicators being devised from time
to time. To
help get started, the following are
amongst
the most popular indicators, and tend
to be the
easiest to understand.
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More
details
For more information on this topic, see:
Also see Wikipedia for another view of
technical analysis.
Also a range of classic text books on the subject.
Before investing money in the markets, make sure to
check with a qualified financial advisor to check if your planned
investment is appropriate for you.
STOP!
- Are you Share Market Ready?
Whatever
you do,
beware of the sharks
in the ocean!
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