I’ve done my research, found out that the company has good fundamentals. However, when should I buy the stock? How can technical analysis help? Many investors have this common problem, and they don’t know the right price to pay.
Technical analysis helps you identify the strength or weakness of the security by using price patterns and trends. By combining with fundamentals, you can have a powerful trading strategy.
Question for you, did you buy a stock because the financial health of the company qualifies as a good investment?
If you did not consider the price, then you did not use technical analysis to find the best entry and exit.
I remember when I bought too many stocks solely because of the stock’s key financial ratios. For example, I acquired multiple shares of the company when the PE ratio was under 10.
In the first place, I have known that I was buying cheap stock. However, I did not look at the chart, and in the end, I lost 50% of the trade because I entered at the top.
I was doing it repeatedly, and have realized that I have to do something.
I learned it the hard way, and I will never do that again.
You probably did the same thing in the past. How did it turn out?
I have been there before, and I know what it’s like.
Fast forward to the present, I have been using technical indicators to complement my fundamental analysis. Moreover, I use the momentum strategy in all my trades.
However, let’s talk about what is a technical analysis below, and later; I will share what I have learned in my trading over the years.
I will teach you the basics, tools, and practical applications that technicians use.
If you have any questions just leave a comment below, and I will answer them as quickly as possible.
What is technical analysis?
Technical analysis is the opposite end of fundamental analysis. Instead of digging the key financial ratio of the company, you’ll look at the historical data of price.
Moreover, technicians believed they can predict future price movements by analyzing price changes, patterns and trends in the past.
As old as the 18th century, Homma Munehisa, an Asian, introduced the candlestick techniques which many traders use in stock trading.
The chart looks like a series of candles.
Technical analysis has three main principles:
- Market action discounts everything
- prices move in trends
- history tends to repeat itself. (source)
First, the price includes all information available for the stock. Second, the stock moves in trends which are either up, down, or sideways. Third, the behavior of investors and traders repeats itself, and it can be predicted.
When I learned about technical analysis, I did not believe it to be true immediately. So, I made a research, and here is what I found.
I have observed many times that stock price often rises before excellent earning reports. After the news came out, the stock plummets usually.
Why did the market have reacted in the opposite direction? It is because the stock has been priced in.
Professional traders do not buy near the day of the earnings report because of the above reason.
That is why I don’t buy stocks based on news. So, what technical analysis do we use to find the right entries and exits?
Well, I like using momentum, breakouts, support, and resistance. I use the first one mainly because it’s easy, and I do not have to monitor the stock every day.
I want money to work for me, and I can do that by looking at the strength of the security. Now, let’s talk about support and resistance, and see if it can help us.
Support and resistance level
If you’re talking about technical analysis, you probably know about support and resistance. These are barriers that prevent the stock price from pushing through a psychological level.
It is an area on the chart where supply is high enough and there are so many sellers.
For example, look at the chart below. The red line at the top is the resistance. It is a strong brick wall that blocks the price from moving up.
As you can see, the price did not break the line. Professional traders do not buy in that area because of the extreme risk to the downside.
Hedge funds and larger institutions take profits in that area usually. However, I’ve written a post about MACD to determine if the resistance can be broken easily.
You can search our site at Google about our MACD post. I recommend that you read my article about it.
Well, you may ask, why I did not put a search button on my site?
It is because I do not want to slow down my website.
If you’re interested you can go to that post now unless you want to continue reading.
I buy below the resistance to anticipate a breakout if the MACD bars are small.
On the contrary, the support level is a strong area on the chart in which you enter a trade after a pullback, and there are so many buyers.
The green line on the charts can stop the price from declining more. I like to take my entries at the first line.
However, I set my stop loss below the next one.
Even so, I don’t use support and resistance(S and R) usually in my trading because traders draw lines on the chart, subjective.
The majority of the time, S and R levels are different for all traders, and they must develop an eye for the charts.
You probably know that whoever controls the market has set the real support and resistance areas. However, it may be the way retail traders have been taught.
I only use the 52-week, high and low in my trading, and I’ll share that with you in a moment.
Up-trend and downtrend start with breakouts usually, and if you catch it as soon as possible, you are set to profit from around Twenty to Two Hundred percent.
I gave out the range because it is not absolute, and you’ve got to get in early on to maximize your profits.
A breakout happens when the price of the stock moves outside the support and resistance areas.
Most of the time, the volatility will increase and the market will push the security either upward or downward.
You can simply detect these kinds of moves by using technical analysis instead of studying purely the financial health of the company.
As a caveat, if you search in Google about breakouts, you’ll find a lot of trading strategies that are wrong.
The authors will tell you that the more the price touches the resistance the stronger the barrier becomes. However, the opposite is true in real trading, and I will explain to you exactly what I mean.
Why support and resistance are frequently visible in a stock chart?
Well, if you do not know why then here is the simplest reason I can give you.
More sellers create more supply the often result in the decline of the security.
Well, the more buyers the greater the demand for the stock that pushes the price up.
If you have more questions about this topic, please leave a comment below.
Now, let’s discuss why 95% of traders fail when anticipating a breakout.
You have been taught that support and resistance become stronger if the price hits it several times.
Am I right? Were you scared to take the trade?
When I did my backtest, I found out that when the price hits the resistance at least three times, a breakout happens usually.
Why do you think it happens?
When the price takes out the supply several times, the sellers are becoming lesser, and they began to doubt themselves.
The same is true when the price is near support areas.
Did I just shock you?
That is why I love buying below the resistance and selling above support.
Momentum is my favorite trading style. You probably know that some traders call it trend following.
Well, either case, you are just following the price.
If there is no momentum, I do not trade it.
Nicolas Darvas turned his small trading account by buying stocks following strong trends.
He did it by drawing a box on stock charts. He buys the stock whenever the price breaks the resistance.
I’ve shared the code on the stock screener page to implement Darva’s strategy. You can check it if you like.
Technical analysis can really help you to find out the strength or weakness of a stock.
However, drawing a box on the chart is a good strategy, it is still subjective.
Moreover, traders plot the box differently. So, I don’t use it usually in my trading.
For me, I use technical analysis only to find out if the stock has momentum.
If there is a strong trend buy it, otherwise just sell it.
The best technical indicator I use is the 52-week high or low. I prefer it because it’s easy to use.
I have written a lot of articles about it, and I found that buying 20% below the high is profitable.
Technical analysis can help you determined if the stock is strong or week. I hope something today. You read our recommended strategies for more information.