Exploring Technical Analysis – Basic Indicators

Basically, an indicator is anything used to predict future financial or economic trends. With this definition, there can be an infinite number of different indicators, and to the new investor it can sometimes seem like there actually are. The important thing to realize about indicators is that no one indicator is suitable for all situations. Most technical indicators are useful only under certain circumstances, or sometimes only for certain industries or for certain classifications of stocks. Indeed, some specialized indicators are only useful for specific individual stocks. Here we will give short descriptions of several of the most commonly used indicators; this should provide you with some insight on using indicators to inform your own investments.

Bar Chart

Bar charts are very popular with technical analysts because they show the open and close price, as well as the high and low, for a particular day. The top of the bar indicates the highest trade price during the day, the bottom of the bar shows the lowest, the opening price of the stock is shown using an indicator on the left side of the bar, and the closing price is shown using an indicator on the right side of the bar.

Relative Strength Index (RSI)

This commonly used indicator measures a stock’s recent performance related to its historical performance by comparing the number of times the stock has recently closed up or down, and by how much, to the same historical data. A stock with a high RSI (above 80 or so) is often thought to indicate an overbought condition (a sell signal); a low RSI on the other hand might indicate an oversold stock (a buy signal).

Trading Ranges

Trading ranges refer to the high and low values for a stock over a period of time. These high and low values establish boundaries defined by support (high) and resistance (low) lines. A breakout from a trading range occurs when the value of a stock goes above the support line or below the resistance line; breakouts are considered to be indicators of an impending price move in the direction of the breakout. The significance of the breakout depends on such factors as the duration of the trading range (the longer the duration, the more significant the breakout) and the narrowness of the range.

Pattern Analysis

Pattern analysis refers to the practice of analyzing charts for specific historical patterns that might indicate future behavior. Pattern names generally give excellent clues to the shape of the pattern on a graph. Some commonly observed patterns are:

• The head-and-shoulders pattern, which refers to the pattern observed when a stock rises to a peak, then declines, rises to a higher peak, declines once more, and then finally rises to another peak which is a slightly lower peak around the same level as the first.
• The rounding bottom often occurs as a company is undergoing recuperation after a series of bad business decisions. The ‘rounded bottom’ shape is observed when the stock’s values are connected on a graph to form a pattern that also looks like a smile, or a “U”.
• The cup and handle pattern. The ‘cup’ portion of this pattern looks similar to the rounding bottom pattern, but is accompanied by a ‘handle’ portion on the right which indicates a sideways or downward trend for a period of about four days to four weeks. The handle pattern is often followed by an increase in stock price.

Trend Analysis

Trend analysis examines short-term and long-term trends and identifies points where prices diverge from their long-term average values (referred to as moving averages). The most common tool in trend analysis is the Moving Average Convergence Divergence (MACD). The MACD is also considered useful in identifying overbought and oversold conditions.

Gap Analysis

When the opening price of a stock is significantly lower or higher than its closing price on the previous day, this is referred to as a gap. Usually this occurs due to overnight news releases or other influencing factors. Gap analysis deals with the analysis of these gaps in attempt to determine further movement.

Disclaimer: The author is not a registered investment advisor. The opinions and experiences expressed here are solely those of the author and are provided as general information. Do not make any investment decisions that you are not personally comfortable making, and consult a registered financial advisor if you have any doubts or questions.