We have learned that one may use fundamental or technical analysis as an effective method in investing and speculating in stocks.
Fundamental analysis uses external information such as the financial condition of a company along with other factors such as the state of the economy and its possible impact on business, particularly on the company that the investor is interested in.
Technical analysis is the reverse. It ignores all the fundamental aspects surrounding the company.
It focuses instead on so-called internal information, namely the price patterns created by the actual buying and selling of the shares of stock.
Between the two, it is said that technical analysis can read the rhythm of price movements better. Instead of just being able to give a general direction of prices at some vague time in the future - something that is attributed to fundamental analysis - it can actually give clear signals when prices will begin to go up or down and how far they will go.
And depending on the way you process your trade following the precepts of technical analysis, you can be either a called picker or a follower.
When one focuses on picking the bottom or top prices of a stock, he is said to be a picker. When he is concerned more in getting a confirmation of the direction and trend of stock prices rather than on capturing the stock's top or bottom price, the person is called a follower or trend follower.
What's amusing with the picker and follower is that both share a common index reference where they base their trading moves on chart formations and patterns. Let's begin our examination of chart formations and patterns with the theory of trends and trend lines. This is the crux of decision making for the followers.
The theory behind trends and trend lines is that prices move in trends because of the imbalance of supply and demand for a given share of stock.
When the supply of the shares is greater than the demand for it, the trend will be down since there are more sellers than buyers. When demand exceeds supply, the trend will be up. Buyers will bid up the stock price.
If the forces of supply and demand are nearly equal, the market price of the stock will move sideways in what is called a trading range.
Eventually, new factors will enter the market and the stock price will begin to trend again either up or down, depending on whether the new factors are taken in positive or negative light.
Trends that are very brief are called minor trends. Those that may last for a longer time such as several weeks are called intermediate trends. Trends that may last for a month or longer are called major trends.
Trend lines determine which trend is in force. You will know that the price of a stock is trending up when, after drawing a line connecting each successively higher bottom, the prices of the stock remain above this line.
The uptrend is in force, as they would describe it. Conversely, a downtrend is in force if prices are below the line connecting each successively lower top (See examples in the book Technical Analysis of Stock Trends by Robert D. Edwards and John Magee).
The main theory of trend line states that once it is penetrated or broken, the trend previously in force is reversed. An uptrend, therefore, that is violated or penetrated is a signal to sell.
A downtrend line that is broken is a signal to buy. The violation, however, is not decisive enough. You must wait for a second line point, another higher top or lower bottom as the case may be, to connect with.
The trend becomes more valid if prices establish a third bottom or top point to connect your second line bottom or top point. At this juncture, stock prices are said to have been tested on its downtrend or upward trend. And, prices have held on, as they technically describe it.
Very steep trend lines are not considered very authoritative. These kinds of trend lines are most often broken by a brief sideways movement of prices (called consolidation) that allows prices to shoot up again. It is the trend lines with gentler slope - either upward or downward - that usually offer more technical significance.
In summary, factors to consider in weighing the validity of a trend line include the number of bottoms (or tops) that have formed on or near the trend line; the overall duration of the trend line; and the steepness of the angle.
The successive sharp drop in prices causes a steep downtrend pattern. Often, this trend line will be broken by sharp rallies, at which point a new trend line must be drawn.
This second trend line might be broken by another rally and a third trend line would need to be drawn. These lines are called "fan lines" (owing to their fanning ray-like lines spreading out).
The rule on fan lines is that, when the third downtrend fan line is broken, the trend has changed on to the uptrend, and vice versa.
The changing of trends can be obfuscated by what is called pullbacks or throwbacks. They occur after a trend line is broken.
Even professional traders become victims of this phenomenon. When they buy or sell as a trend line is broken, the price of the stock after a few days will go higher than the price at which the trend line was broken. This is the pullback.
A pullback may also never materialize. In order not to be waylaid by this phenomenon, it is recommended to buy or sell half of your position on the trend line break and the other half on the pullback.
(The article has been prepared for general circulation to the reading public and must not be construed as an offer to buy or sell any securities or financial instruments referred here or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that can affect the objectivity of their reported investment activity. You may reach the Market Reader at densomera@yahoo.com)
Fundamental analysis uses external information such as the financial condition of a company along with other factors such as the state of the economy and its possible impact on business, particularly on the company that the investor is interested in.
Technical analysis is the reverse. It ignores all the fundamental aspects surrounding the company.
It focuses instead on so-called internal information, namely the price patterns created by the actual buying and selling of the shares of stock.
Between the two, it is said that technical analysis can read the rhythm of price movements better. Instead of just being able to give a general direction of prices at some vague time in the future - something that is attributed to fundamental analysis - it can actually give clear signals when prices will begin to go up or down and how far they will go.
And depending on the way you process your trade following the precepts of technical analysis, you can be either a called picker or a follower.
When one focuses on picking the bottom or top prices of a stock, he is said to be a picker. When he is concerned more in getting a confirmation of the direction and trend of stock prices rather than on capturing the stock's top or bottom price, the person is called a follower or trend follower.
What's amusing with the picker and follower is that both share a common index reference where they base their trading moves on chart formations and patterns. Let's begin our examination of chart formations and patterns with the theory of trends and trend lines. This is the crux of decision making for the followers.
The theory behind trends and trend lines is that prices move in trends because of the imbalance of supply and demand for a given share of stock.
When the supply of the shares is greater than the demand for it, the trend will be down since there are more sellers than buyers. When demand exceeds supply, the trend will be up. Buyers will bid up the stock price.
If the forces of supply and demand are nearly equal, the market price of the stock will move sideways in what is called a trading range.
Eventually, new factors will enter the market and the stock price will begin to trend again either up or down, depending on whether the new factors are taken in positive or negative light.
Trends that are very brief are called minor trends. Those that may last for a longer time such as several weeks are called intermediate trends. Trends that may last for a month or longer are called major trends.
Trend lines determine which trend is in force. You will know that the price of a stock is trending up when, after drawing a line connecting each successively higher bottom, the prices of the stock remain above this line.
The uptrend is in force, as they would describe it. Conversely, a downtrend is in force if prices are below the line connecting each successively lower top (See examples in the book Technical Analysis of Stock Trends by Robert D. Edwards and John Magee).
The main theory of trend line states that once it is penetrated or broken, the trend previously in force is reversed. An uptrend, therefore, that is violated or penetrated is a signal to sell.
A downtrend line that is broken is a signal to buy. The violation, however, is not decisive enough. You must wait for a second line point, another higher top or lower bottom as the case may be, to connect with.
The trend becomes more valid if prices establish a third bottom or top point to connect your second line bottom or top point. At this juncture, stock prices are said to have been tested on its downtrend or upward trend. And, prices have held on, as they technically describe it.
Very steep trend lines are not considered very authoritative. These kinds of trend lines are most often broken by a brief sideways movement of prices (called consolidation) that allows prices to shoot up again. It is the trend lines with gentler slope - either upward or downward - that usually offer more technical significance.
In summary, factors to consider in weighing the validity of a trend line include the number of bottoms (or tops) that have formed on or near the trend line; the overall duration of the trend line; and the steepness of the angle.
The successive sharp drop in prices causes a steep downtrend pattern. Often, this trend line will be broken by sharp rallies, at which point a new trend line must be drawn.
This second trend line might be broken by another rally and a third trend line would need to be drawn. These lines are called "fan lines" (owing to their fanning ray-like lines spreading out).
The rule on fan lines is that, when the third downtrend fan line is broken, the trend has changed on to the uptrend, and vice versa.
The changing of trends can be obfuscated by what is called pullbacks or throwbacks. They occur after a trend line is broken.
Even professional traders become victims of this phenomenon. When they buy or sell as a trend line is broken, the price of the stock after a few days will go higher than the price at which the trend line was broken. This is the pullback.
A pullback may also never materialize. In order not to be waylaid by this phenomenon, it is recommended to buy or sell half of your position on the trend line break and the other half on the pullback.
(The article has been prepared for general circulation to the reading public and must not be construed as an offer to buy or sell any securities or financial instruments referred here or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that can affect the objectivity of their reported investment activity. You may reach the Market Reader at densomera@yahoo.com)
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