If you are thinking of investing in a stock, you probably heard that technical analysis can help you when to buy a security. However, which ones should you look at?
For investment purposes, technical analysis looks at whether a stock has established momentum in price to find the best entry and exit in the market. Although the security has shown growth potential, it must signal strong strength.
Technical analysis is also applicable to find the weakness of the stock. In addition, your question is only about investment. Thus, I will share with you why I use technical analysis, and that is to find momentum.
If you’re a regular reader of this website, you probably noticed that I look for stocks with high momentum.
I do it because I want to invest only in strong stocks.
First, if you invest in a stock that has price consolidation, you’ll have to wait for years before you can earn a profit. Second, you can invest in better stocks that have a strong uptrend. Third, even if you find security with an excellent fundamental catalyst, the market may have not loved it yet.
It can take several years before the market may notice the stock.
Why look at momentum?
You don’t want to put your hard money in a dead investment. I know you want to increase your wealth as fast as possible.
Of course, you can’t do that with a weak stock, although the security has a strong fundamental catalyst.
You have to use technical analysis to find high momentum stocks. Looking at the stock charts can help you do that.
I have seen it over and over. It is just common sense, do not buy a stock that does not move.
It does not mean that the stock is not worth anything. Sometimes, the market has not found it.
So, what can you do?
You can add the stock to your watch lists and hope that someday it may gain significant interest from the public.
I don’t want you to waste your time and money on a sleeping giant. It may not wake up.
You already know that with a small capital, you need to grow it as fast as possible to be significant.
Let’s dive into some strategies you can use to determine the strength of the stock.
Breakouts are a classic when it comes to technical analysis. Stocks that broke a strong resistance have proven to increase in price in the next few weeks, months, or years.
Usually, it happens because of fundamental catalysts that ignite the breakout. In addition, It is due to news and rumors.
Traders have increased interest in the stocks during breakouts because they want to be where the action is.
However, breakout does fail sometimes.
An uptrend usually begins with breakouts. If you look at the higher highs and higher lows, they usually start with a breakout.
You can use breakouts to determine the strength of the stock either daily, weekly, monthly, or yearly.
For example, The Turtle traders use the 20-day or 4-week breakouts.
Moreover, most position traders use the 6-months or 12-month period.
Patience is the key. Even if you found a good stock because it looks excellent, don’t buy it immediately. Doing It has helped me since the day I started investing.
I like to see immediate results when I buy a stock. Likewise, I ditch the weak ones the soonest.
However, I don’t use any of these strategies because I use only the 52-week high.
52-weeks high is my favorite indicator when it comes to looking at momentum. Technical analysis has been easy for me because of it.
I buy only the stock when the price is within 20% below the 52-week high.
It is part of my momentum trading strategies.
In addition, most of them are anticipating a breakout. However, beginners will buy only at the break of the high which is already too late.
I use a free tool from investing.com, and I use it every day. The tool is easy to use. You don’t need to buy a stock screener.
Nevertheless, do not trade this immediately because what I’m sharing with you is only part of my trading system.
Moving on, when the price is below 30% of the 52-week high, I consider already the stock to have lost its momentum.
Additionally, what I do after the price has dropped below 30% is exit the trade.
It just doesn’t make sense to hold a stock that does not have strong momentum.
I would prefer stocks that can give me the fastest profits at the least possible time.
Moving average is also basic. It is one of the widely used indicators by stock traders.
This indicator has two types, which are simple and exponential moving average.
In this post, we will only look at the SMA.
SMA is a lagging indicator because it uses past data. It is a customizable indicator that a user can change the parameters.
But how do you use it?
Many variations of trading moving average have been throughout the Internet.
However, you only need three moving averages to know whether the stock has momentum.
The stock has a strong momentum if the price is above MA20, MA50, and MA200.
It is very easy to scan these parameters with Amibroker. You can also use both MA50 and MA200 to trade.
Swing traders use MA50 while large institutions use MA200 to trade a stock.
As a caveat, I don’t use moving average in trading because I don’t think big institutions use it to invest in the stock.
You can not rely on a lagging indicator because the signal is usually late.
However, there is a method that you can use to anticipate price movement. However, it requires you to code it in Amibroker.
Maybe I will share it, with you later.
As an alternative to a 52-week high indicator, I also use the Relative Strenght Index(RSI) indicator to see if the stock has strong momentum.
RSI is popular among traders because it uses the recent price changes of stock.
The old method of using it has been the overbought and oversold levels of 70 and 30 respective.
The most common setting of RSI is the 14 day period. The indicator will rise as the number of upward movement in price increases. On the other hand, the RSI will fall as the number of losses decreases.
However, we use the 30 periods to clear out the noise in the market. Moreover, based on my experience, when the RSI > 50 and RSI <70, the stock has a strong uptrend or momentum.
Any stock with RSI below 50 has a bearish signal.
I use this indicator only if I can’t find stocks with prices near its 52-week high.
Once, the indicator breaks the 70 level resistance, the stock is considered as parabolic.
Parabolic is a state of strong momentum. At this state, the stock will burst on the upside until level 80 RSI.
The breakout is effective if the weekly RSI(30) is the first to break out over daily RSI.
Altogether, we look at momentum when we use technical analysis for investment purposes. We are only looking in one direction here because we are trying to buy the stock.
You don’t look at falling stocks when investing.
In the long run, if you only buy stocks with a strong uptrend, you will beat the market.
However, do not forget about fundamental catalysts that drive the stock up.