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Friday, April 13, 2012

Let's Talk Technicals

Okay, for the uninitiated, "technicals" and Technical Analysis is just fancy talk for stock Charts and the overlays, indicators and oscillators associated with charts which are used to help evaluate the expectations on a stock's price movement. Fundamentals (see two earlier posts) always trump technicals, but technicals are a VERY useful tool, once you've learned them. They LOOK a lot more complicated than they really are. There are tons and tons of books on the subject. I suggest for the beginner a simple little book called "Sticky Charts" to learn a bit about patterns and reading them.



By the way, studying charts is one of my favorite pastimes. It is SO fun, like figuring out a crossword puzzle.

Every good options broker's website is going to have a tutorial on charting. Google "stock charts" on the internet and you'll find months of reading. And of course there are endless books on charting. "Candlestick Charting for Dummies" even! It would be worth your while to read more than one book, but don't make the mistakes I made. I got over-enthused and thought I needed to know EVERY indicator and oscillator known to mankind. When I set up my early charts, they were two feet long with all the added indicators. Truly not necessary.

The charts will be available on your broker's website too, and many other free and paid websites have charts that look a little different and have different choices of indicators. You just have to poke around and see what you like, after you learn the basics. I prefer StockCharts.Com because their charts are so fabulous looking, and they have lots and lots of bells and whistles. You can do free charts or paid charts and get more.

After years of fooling around with indicators and combinations of indicators (there are MANY creative souls out there selling you "magic" based on "new" discoveries with indicators) I realized that THREE and only three would serve me very well, if I knew them, used them, and truly followed the signals they provide.

THE NAKED CHART

But first, let's look at a 'naked' chart. You can have charts that represent the movement of stock prices by days, weeks, years, minutes. It's all up to you. If you do long term trading, you probably want to look at years of activity to decide the patterns of that particular stock. If you are a mid term trader, then daily charts will probably suit you just fine. For short term day traders, they like to look at one minute and five minute charts, as their trading is fast and furious.

I like to do weekly and near-month trades, so I use the daily charts for an overview and the 15 minute charts to watch the trends change. So here is a candlestick (my chart of choice) chart with no embellishments.



All the Chart programs these days allow you to write all over the charts, and draw lines and all sorts of gizmos on them. One thing that is often helpful is to draw trendlines. (with this chart on Apple, it's not hard to figure out what the trend is, however). The correct way to draw the lines is that downward trend lines go OVER the candlesticks; upward trend lines go UNDER the candlesticks as shown here. (the lines should touch at least three candles to make it right. But mind you, this is not an exact science, so don't get anal about it.



THE OVERLAYS

THE EMA'S

On the face of the naked chart, you can set parameters for "moving averages" which flow behind your candlesticks or overlay them, so to speak, and provide a lot of information and your first "signal" to look for.

A signal is just that, it is an "event" that tells you the stock is about to move in a particular direction. Think that kind of information might help your trading? You bet. But you can't rely on just ONE signal. It could be a fluke, it could be a dud. But if you can get three technical signals all saying the same thing, you have a good chance of predicting where the stock price is going. You can do simple moving averages, but I've been told many times that Exponential moving averages are better, and so I use them. I use a 5 period moving average, a 20 period moving average, and also a 200 period moving average. (this last one is really historic information, but I find it interesting in contrast to where the price is today.) For the purposes of this illustration I shall only chart the 5 day and 20 day moving averages however.

By the way, there are mathematics behind ALL of these technical charts. Every line, every candle is an equation that has been worked out based on the momentum, volume, volatility or some such. Every good book on Technicals will give you this information in vast detail. You don't need to know all the math in order to use the charts. I don't have the head for it, maybe you do. It helps to know that it's not a ouiji board, however. There are sound principles behind this stuff.If you really must know, you can start here: Moving Averages

So here's my Exponential Moving Averages added to my naked chart. I have also added a graph of the Volume at the bottom of the chart. It represents how much buying and selling in total is going on per period.

Please note carefully how the red line and blue line cross each other occasionally. I have used a Caterpillar chart (instead of Apple) for more up and down activity to illustrate the crossovers.

THESE ARE YOUR FIRST SIGNALS.


When the 5 day line (BLUE) crosses up and over the 20 day line (RED), it is a signal that the stock is going to go up. When the blue line crosses down over the red line, it is a signal that the stock is going to go down. Easy peasy. Just remember that the crossover is ONLY ONE OF THREE SIGNALS NEEDED to trust the technicals.

THE OSCILLATOR

R.S.I.

I usually put this indicator above my chart, where it is separate from the other indicator which I put under the chart. This top side indicator is called the R.S.I. which stands for Relative Strength Index. 50 is the midpoint on the RSI indicator. If the line goes over 50, it indicates an overbought condition, and below 30 indicates an oversold condition. The point is to make sure the direction of the line is matching the signal you are getting from the Moving Average crossovers, Plus one more indicator.

If you must have the mathematics, try this: Relative Strength Index



THE INDICATOR

MACD

The Moving Average Convergence Divergence is the third and last of our Buy/Sell Signals.

For all the details of its innards, here's a link for you: MACD and this is what it looks like beneath my chart. Note there are two lines (much like our overlay moving averages) PLUS a histogram which builds up and falls down along with the price.

So here's my chart, with all the pieces, stacked up: RSI on top, the candlestick chart with EMA's, the Volume graph and the MACD. Note that the circles represent where the signals are. If you have THREE SIGNALS, it's a buy or sell signal. (up or down)



I haven't circled every signal on this chart. See if you can find additional crossovers as well as additional "false signals" (where there's only one or two and NOT all three to verify.) This is the most cursory description of Technical Analysis, and is only MY way, MY opinion, and what I've learned. There are hundreds of different oscillators, indicators and overlays. You will learn many of them, use them, discard them and find the ones that make the most sense to you. But this will kick you off with some bare basics. I welcome all questions and comments. Be KIND. I'm still a student too. :-) ##

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