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Date: Tuesday 13th 2008f May 2008 02:48:16 PM

Getting Started in Technical Analysis

By: Novice Investing Staff
 
 
Technical Analysis is the study of past price and volume movement of stocks to predict future behavior. Stock's past behavior can be observed through graphs and charts. In a glance, stock moved in a random fashion. Further analysis shows that it is not always the case. In some cases, stocks can move in a somehow predictable fashion. Here, at noviceinvesting, we believe in combining the power of fundamental and technical analysis to maximize our investment return. Let's learn about the basic definition of technical analysis.
 
Support Resistance
Support and Resistance is horizontal line drawn at a certain stock price. Here is a 10 month chart on Merck &Co., Inc. (MRK).. Why are these lines important? This is because we as human beings have memories. When MRK bounces from $43 on March of 2004, we remembered. As MRK approaches $43 level on August of 2004, people start bidding up on MRK based on their past experience. This does not mean that support/resistance line is unbreakable. However, support/resistance line will help you identify potential buyers/sellers in the market place. Most importantly, it helps you avoid selling when there are potential buyers (when price potentially will bounce) and buying when there are potential sellers (when price potentially will drop). This is one of the reason why MRK bounces at $30 on late October of 2004.

 

 

The term support and resistance are relative. When MRK's stock price is lower than the line ($43 line for example), it is called resistance. Because, this is where some potential seller will take their profit if MRK rises to $43. When MRK's stock price is higher than the line, it is called support. This is where potential buyers will appear and support MRK from falling further ($30 line for example)
 

Volume Analysis

Volume and support/resistance line are the basic pillars of technical analysis. Other chart patterns that are taught on books are derived from these two items. Why is volume important? To figure out what every participants think about a particular stock. Big mutual funds and institutions buy in bulks. They leave their trails in the form of volume. When they buy or sell, volume surges. When small investors like us make transactions, volume barely budge.

So, what are we looking at in volume analysis? Basically, you want high (or even huge) volume in the future stock direction that you are looking for. Therefore, if you want MRK to go up, it is good for MRK to go up in high volume while decline in low volume. What this means is that big investors are buying up MRK even when it goes up in price. On the other hand, they are less inclined to sell MRK when the stock price went down.

The graph below shows a 10-month chart on Apple Computer, Inc (AAPL). It seems to me that institutional investors have been buying AAPL at $22 all the way up. (If you look at longer time frame, it is actually $16).

 

 

 

On the other side of the spectrum, it is bad when stock declines in high volume while rises on smaller volume. I pick Krispy Kreme Doughnut here as an example of buy low sell lower. The moral of the story here is to not do the OPPOSITE of what other big institutions are doing. They have first-hand information of what is going on with the company. We only know what the press tells us. When they are selling, do not buy. Wait until they are done selling and then make your move if you like it as an investment. 0% return on your investment is way better than losing your money due to your impatience.
 

 

 

 

I just taught you a quick glance of Technical analysis. While useful, it is by no means the most accurate way of forecasting the future. The future is always uncertain. Even big institutional investors are wrong sometimes. But if they, who know first-rate information, are wrong, we would be too.

My suggestion is to use your fundamental analysis skill to determine the value of a company and then look at technical analysis to determine your entry point. You do not want to buy when other big investors are selling. Let's move on to a more deeper look at Technical Analysis.
 
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