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Unsure of the difference between long-term and short-term investments? We examine the characteristics of each and when to use them.

Using technical analysis to research stocks includes using data and indicators to help identify trends and patterns that can help guide investing or trading decisions. It’s one of the two main forms of stock analysis, the other being fundamental analysis.

Using technical analysis indicators to evaluate stocks isn’t necessarily easy, and can be risky for investors who may not know exactly what they’re doing. With that in mind, it may take a long time for investors to feel comfortable with their technical analysis skills — but knowing the basics of technical analysis can be helpful for investors of all experience levels.

What Is Technical Analysis?

Technical analysis uses numerous data points and indicators to evaluate stock performance, and help guide short-term trades. Technical analysis is an investment strategy by which investors try to forecast how a stock price will move based on data about its past movements.

Technical analysis relies on various stock movement indicators, such as price and volume, to identify patterns and trends. Technical analysis only considers a stock’s price and does not consider other factors, such as how a company operates, its earnings, or its assets.

How Technical Analysis Works

Technical analysts chart this data to help them identify patterns while trading stocks. Think of these charts as trails that stocks leave behind them as prices move up and down.

One of the basic tenets of technical analysis is that history tends to repeat itself. By examining market volatility more closely, analysts may see patterns emerge and can thereby make an educated guess about where stock prices might be headed when current patterns line up with historical patterns.

For example, it may become clear that stock prices move a certain way at a certain time of year on a stock chart. A retailer that might see an uptick in share price during the holiday season, for instance.

Or, maybe it becomes clear that a stock reacts a certain way during specific market conditions. For example, when the price of steel rises, analysts may see a shift in the stock price of auto manufacturers.

Anyone can use technical analysis while investing online, though some of the indicators that traders use to analyze stocks may be a bit on the complicated side. However, knowing some basics can be useful even for lay investors to help them make informed decisions about the stocks they choose.

What Are the Core Concepts of Technical Analysis?

Investors who use technical analysis have a number of tools available to help them analyze stock. That generally includes reading different types of stock charts, identifying market trends, as well as common market indicators.

How to Read Different Types of Stock Charts

Technical analysis is all about keeping track of the trail that stocks leave behind. One of the ways that investors and analysts organize this data when doing self-directed investing is with stock charts, including bar, line, and candlestick charts. These charts can cover wide or short time frames and show the patterns of how trades are executed.

You’re likely familiar with line and bar graphs in which the height of the bar or line illustrates the up and down movement of the stock. Candlestick charts may be a little bit less familiar and can be an extremely useful tool if you can read them.

Candlestick Charts

Candlestick charts are made up of distinct pieces, called “candlesticks,” that look like a cylinder with a line coming out of the top and bottom. The cylinder and the lines should be read as three parts. There are four pieces of data represented in each candlestick: opening price, closing price, and the high and the low.

Additionally, each candlestick represents a period of time. Say one candlestick represents five minutes. Within that five-minute period, the bottom of the body of the candlestick represents the opening price of a stock and the top of the body represents the closing price.

The line extending downward from the body represents the low within that time period, and the line extending upward represents the high. If the closing price is higher than the opening prices, the candlestick is colored green, and if it’s lower, the candlestick is colored red.

Each candlestick is read in the context of the other data points around it, and gives analysts a detailed look at how investors are buying and selling stocks over a given period of time. Certain candlestick shapes can be an indicator of distinct changes in the market.

A hammer candlestick has a low, low price, but its closing price is close to its opening price, indicating that prices have potentially hit a low and are reversing. Its inverse, a shooting star candlestick, indicates that prices may have peaked and are on their way down.

Identifying Chart Trends (Uptrend, Downtrend, Sideways)

Technical analysis looks for trends that can help indicate the direction a stock price is moving.

•  As the stock price goes up, it is on an upward trend.

•  As it goes down, it’s on a downward trend.

•  If a price remains relatively constant, the chart will look flat, or sideways.

By comparing current trends to historical data, technical analysts may be able to predict where the trend is headed and what points may represent its highs and lows.

Understanding Common Momentum Indicators (RSI, MACD)

Analysts can measure the strength of trends and movement in price by taking a look at momentum indicators. This indicator compares the most recent closing price to previous closing prices. In a stock chart, the momentum indicator is represented as a separate line from the price line.

Momentum indicators may be expressed as the difference between the current closing price and the closing price a certain number of periods ago. Or it may be expressed as a percentage, or rate of change, by dividing the current closing price by a past closing price.

In general, momentum indicators are used less to provide a signal that investors should make a trade than they are used to help support trades made based on other price actions. For example, if the price of a stock is moving down but downward momentum is slowing, it may help provide confirmation it’s a good time to buy if other indicators also show it’s a good time to buy.

There are numerous indicators, including the relative strength indicator (RSI), and moving average convergence divergence (MACD).

RSI

The relative strength index, or RSI, looks at price fluctuations during a given time period, and calculates average price losses and gains. It ranges from 0 to 100 — a score higher than 70 is considered overbought and under 30 is thought to be oversold. The RSI may identify a divergence, when the indicator moves in opposition to the price.

MACD

The Moving Average Convergence Divergence (MACD) helps investors gauge whether a security’s movement is rising or falling, and helps gauge the momentum of the trend. The MACD uses two different exponential moving averages (EMAs) to do so.

Volume

Stock volume is a measure of the number of shares that are being bought and sold during a given period. Another way to look at volume is that it represents investor interest in a stock. The more stock being traded, the heavier the volume and the greater the interest.

Investors can look at volume as an indicator that prices are changing, and rising volume can be a sign that stock price is starting to move in a significant way.

That said, it is possible that high volume can represent the end of a trend. For example, investors hoping to take advantage of a rise in a stock price may pile on at the end as the stock price is reaching its peak and just about to fall.

Support and Resistance Levels

One of the patterns that analysts will look out for when looking at stock charts are certain thresholds at which stock prices tend to rise or fall. The support level is a point to which a stock will sink but won’t usually fall any further before rising again.

It is essentially the level at which demand is strong enough to bolster the price. Conversely, there is also frequently a price ceiling that stocks will hit that may cause prices to fall back down.

This is the resistance level, the level at which selling is strong enough to prevent prices from rising. Investors may pay attention to these levels, choosing to buy when prices are near the support level or sell as prices meet the resistance level.

Moving Averages

Price movement over a given period of time can make a stock chart overwhelming to look at. The ups and downs of the line can be visually confusing and messy to look at. A way to simplify and show trends more clearly is by using a moving average.

This indicator focuses less on day-to-day movement and more on average price over time. A simple moving average (SMA) takes the sum of the closing prices over a given period of time and divides by the number of prices used. So if you were looking at a three-month period, you would add all the closing prices up over that period and divide by 90.

What Are Chart Patterns and What Do They Signal?

In the simplest terms, chart patterns reflect stock market data, and can be used to identify certain pricing trends. As discussed, there are several types of charts, and thus, several types of chart patterns that may be used to try and parse out market signals.

Those patterns could include candlestick patterns, mult-bar patterns that generate “triangles” or “rectangles,” and more. Trying to discern if these patterns are indeed signaling specific price movements, is a high-level endeavor undertaken mainly by professional traders. That is, they may be a bit too advanced for many inexperienced investors.

Technical Analysis vs. Fundamental Analysis

Fundamental analysis is another school of thought you may encounter when evaluating stocks. This strategy is quite distinct from technical analysis. For technical analysts, price movements are paramount. That’s why technical analysts are always looking at price, and always looking for price patterns that can indicate which positions to take.

The fundamental analysis school of thought takes a deeper dive into a stock’s intrinsic value by looking at factors such as the underlying company’s financial statements, its assets and liabilities, how the company is governed, and the overall market and economy.

Whereas technical analysis is focused almost entirely on numbers, fundamental analysis looks at both qualitative and quantitative measures to determine the fair market value of a stock and compare whether its current price on the market is over- or under-valued.

That said, technical analysts would argue that the factors examined through fundamental analysis are already accounted for in the price of stock. As a result, they might say that examining price and trends is a more efficient form of analysis.

How Beginners Can Start Using Technical Analysis

The average investor interested in experimenting with technical analysis can turn to a variety of sources to find data sets and indicators to track the past price and performance of stocks. This is primarily for short-term trades; technical analysis typically does not factor into long-term investment strategies like asset allocation.

It should be noted that accurately predicting the future price movement of stocks is impossible. In fact, the efficient market hypothesis states that because markets are efficient, a stock’s price reflects all available information about a stock. And nobody has a crystal ball — so, no matter how confident you are about a stock’s future movement, remember that there’s always risk involved.

Common Mistakes to Avoid With Technical Analysis

There are potential mistakes that investors can make when utilizing technical analysis tools. These can include things like emotional or impulsive trading, which could happen if an investor sees an emerging trend in the data and decides to make a quick decision, perhaps at odds with their broader investment strategy.

In short, the data or trends that technical analysis may uncover could spur investors to take actions that may be premature or otherwise outside of their intended strategy.

That could also include making investment decisions based on whatever data is in front of the investor, rather than sticking to a plan.

It’s also possible that investors can become overconfident in their skills or analysis abilities, leading to poor trading decisions. Investors could also use too many indicators or tools, overrely on a single indicator, and even misinterpret the data they are seeing.

Suffice it to say, there are myriad mistakes investors can make with technical analysis, which is why it may be a good idea to take a slow approach to it, and test your methods over time.

The Takeaway

Technical analysis refers to a series of tools and indicators that traders use for evaluating stocks or other securities. It leans on market and trend analysis tools to identify price patterns, and place trades to increase potential returns based on short-term price movements. It’s risky, of course, and there are many mistakes that investors can make while utilizing technical analysis.

Technical analysis is a sophisticated set of techniques that are best used by experienced traders.

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FAQ

What is the best indicator for technical analysis?

There is no single best indicator for technical analysis, as it may depend completely upon an investor’s preference as well as the security they’re tracking. That said, some broad indicators may be popular, as they can give investors the largest top-down view of the market.

Can technical analysis predict a stock’s future price?

Nothing can accurately predict a stock’s future price, but technical analysis attempts to give investors an idea of where a stock’s value may be headed. It may be correct sometimes, and others, incorrect.

How long does it take to learn technical analysis?

An investor may never be “done” learning technical analysis, so there is no set time limit. That said, some investors can familiarize themselves with the basics in weeks or months, while others may practice for years.

Is technical analysis better for short-term or long-term trading?

Technical analysis is likely better for short-term trading, as it attempts to uncover short-term market trends or movements, which may not hold over long periods of time.

What are some free tools for practicing technical analysis?

Many brokerages and trading platforms provide technical analysis tools to investors or clients free of charge. There are also other web-based tools that can be accessed for free that investors can use to practice.