How to Predict Trend Changes With Technical Analysis

Technical analysis is an investment strategy that relies strictly upon price and volume information to make decisions. Technical analysts, or technicians, profit by using charts to uncover trends and reversals within individual securities. Reversals refer to changes in trends between bullish advances and bearish declines in stocks. Predicting trend is profitable because doing so allows you to either buy or sell stocks short before large moves.

Things You'll Need

• Brokerage account
• Internet connection
• Financial statements

Instructions

Identification

1. Learn the terminology of technical analysis. Trend identifies the tendency of one stock to move in one direction. Bullish trends apply to stocks that are increasing in value. Bearish trends describe stocks that are losing value. Reversals define changes in trend.

2. Identify chart patterns that showcase bullish trends. Higher highs and higher lows against support levels are bullish. Support levels indicate short-term low points upon the chart.

3. Identify basic chart patterns that showcase bearish trends. Lower highs and lower lows against resistance levels are bearish. Resistance levels are short-term high points upon the chart.

4. Study reversal patterns. Head and shoulders is an easily observed reversal pattern. The head is the high point and is surrounded by two shoulders that are shorter-term highs. Two low points between the head and shoulders touch upon a support level that forms the neckline. Head and shoulders patterns identify bullish trends that become bearish. Conversely, inverted head and shoulders highlight stocks that are becoming bullish.

5. Review personal financial statements to determine the amount of money you wish to dedicate towards technical analysis. Beginners should not experiment with more than 5 percent of their investment assets to avoid large losses.

Application and Investing

1. Reference a 52-week chart pertaining to the individual stock in question. You may also research charts of the major indexes, such as the Dow Jones Industrial Average, for reversal cues applicable to the entire market.

2. Take note of the most recent three to six months of pricing information upon the graph as it compares to the past year. Compare price charts against volume information that is usually presented at the bottom of the graph.

3. Confirm reversals with volume statistics. For example, large volume often coincides with “bottoms,” or low points that occur before a bullish reversal. This large volume demonstrates that investors have capitulated. The stock is set to advance from here, because sellers have already liquidated. Conversely, dwindling volume during a stock advance often translates into a bearish reversal because buyers are becoming disinterested in the stock.

4. Buy stocks that follow bullish reversal patterns. Short stocks, or liquidate positions already in your portfolio that demonstrate characteristics of becoming bearish.

Tips & Warnings

• If possible, dollar cost average into and out of what appear to be reversal patterns. Dollar cost averaging breaks up lump sums into smaller amounts that are invested over time to reduce risk.

• Technical analysis is privy to “head fakes.” Head fakes describe stock price activity that never materializes into full reversals and confuses investors.

References

• Investopedia: Technical Analysis - Introduction
• Investopedia: Use of Trend
• Investopedia: Chart Patterns

Resources

• Investopedia: Chart Types