Understanding Technical Analysis Stocks

Technical stock trading is about finding trends.

Technical analysis is one of two major forms of investment research. Its history and origins date back several hundred years to Japanese and Arabian markets, and it involves the mathematical manipulation of price and volume data to optimize buy and sell points. Technical analysis has become increasingly popular with the use of computerized trading programs and easy access to historical databases.

Technical Analysis Relies on Defining Probabilities

Technical trading seeks to quantitatively measure risk and reward.

Technical analysis attempts to describe the probability of a stock market event occurring based on historical precedents. Technical analysis attempts to translate human interpretations of what should move the market higher or lower into trade-able fact. An example would be a technical analyst demonstrating that when a stock price crosses above the 200-day moving average, the price will continue higher 50 days later 65 percent of the time.

Technical Analysis Uses Price and Volume

Technical analysis does not look at the effect of leverage.

Technical analysis uses historical prices as the principal means of determining the strength, or ability of a stock to rise or fall. Coincident with price is volume. Very good stocks continue to rise when the volume of the stock is also rising. Stocks rising (or falling) in price without a coincident rise (or fall) in volume are said to be diverging, and this usually implies that professional sellers are using the opportunity to sell the stock into strength.

Technical Analysis Uses Several Analytical Tools

Technical analysis requires charting ability.

The most popular method of technical analysis is the moving average. Moving averages are simply computed averages of closing prices based on recent closing price activity. The 10-week, the 20-day, the 50-day, and the 200-day moving average are popular references for technical analysts. Technical analysts average the closing price for the period, dropping the oldest data and adding the newest data as it becomes available each period. Some technicians weight the moving average with additional mathematical configurations such as exponential and volume-weighted considerations.

Technicians Use Pattern Trading

Stock charts give important keys to technical trading.

Technicians discern repeating patterns in trading that are indicative of high-probability moves. Double and triple wedges, pennant formations, and topping formations all represent statistically significant opportunities for traders. There are many pattern trades. All derive from the fact that stocks within an up, down or sideways trend tend to spend much of the time in random patterns. Pattern trades have added significance when volume is high.

Technical Charting Uses Many Time Spans

Good chartists make good traders.

Technicians use stock charts, the plotting of price over time, to present a picture of a stock's movement. Some charting techniques also accompany price charts with volume charts. The important issue in charting is the time measurement employed. Some technicians use daily data, some weekly or monthly data. Yearly data is rarely used except to generalize about long-term trends. Day traders use differing time sequences as well. One-, two-, and five-minute charts are popular, as are one-hour chart points.

Technical Trading Is Difficult

Technical analysis requires persistence and practice. Every time a technical signal is given, the trader must buy or sell as required. Often, the trader will lose money on several trades in a row, only to then win several in a row. The trader continues to trade the signal knowing that the probability of success will provide, on average, a reward much greater than the risk taken on any individual trade. Good technical traders are very disciplined.

Resources

• ImportantTechnical Trader: Ed Seykota