Technical Analysis

A Conversation in Technical Analysis

Reference Points for Everyone

In life and as consumers, we are often missing reference points. We buy cars and trucks, washing machines, get quotes for home services, and more, to always question whether we are getting a deal on something. The new car we drive off of the lot drops substantially in value. We know this, but we still do it. We just have to take it, while knowing there is no way to protect ourselves from that massive depreciation (or loss). Or, we know we need several quotes to put the new roof on our home to try and establish an average or fair price point where we can feel good about ourselves and say we did our research and got the deal, but we still aren’t really sure. We lack the reference point not knowing if what we are paying is good or bad, or what the appropriate and prudent level was. Any immediate price loss leaves us out of luck. Did we find value? How much markup are we paying? Do we just acquiesce and go along with it? Usually, yes, we do.

And it’s the same with the price we pay for our investments. In the stock market, whether we participate through company sponsored retirement plans, IRAs, or taxable accounts, it is the same concept. We frequently hear that this stock or that stock or that mutual fund is cheap (the price at which the investment is trading in relation to where it is on the price chart) from the so called experts or talking heads who claim this or that is going to move up (their firm probably sells research or underwrites for the company), often to learn the hard way that what we were told was cheap when we took their advice, got a lot cheaper, after we bought it. Our capital / equity is now tied up in something for a long time in the hopes that it will rebound to the level which we were told was the “bargain.”

Worse than that, as we traders and investors know, is missing another opportunity that has come along which we cannot now take advantage of because we listened to someone else and were misguided. Our capital is tied up, our friends are making money while we are locked up and don’t want to (or our egos won’t allow us to), take the loss, and we are frustrated and down on our decisions. Where are the experts that touted these bargains to begin with, or our representatives from our company retirement plans, when we need them the most? We want to think independently and empower ourselves, but we don’t know how…

Technical Analysis, the study of price movement, gives you that missing reference point.  It tells you where the investment in question is on the map, where it has been, and where, if you use the right tools, it is about to go. As they say, timing is everything and timing your buys and sells appropriately will not only give you the reference point you need, but can also protect your downside measurably.

No matter how you take a crack at buying something, or what methodology “within” technical analysis you ultimately employ (new high breakouts, buying out of bases, stage analysis, etc.) since a current stock price reflects all current thought about the instrument you want to buy (stock, funds, bonds, etc.), it is reflected, right there for you. The thinking is done for you and displayed there visually for you on a price chart. The investment “collective,” meaning everyone in the world that has a stake or interest in that chart, has already voted on it. Those votes make or will make the chart, past, present and future. You choose to buy at the right time and that gives you your reference point, and puts you in control.

We can all learn, no matter what our background and education, to trade and invest with the tools available in the technical analysis “toolbox,” minimize our losses so we protect ourselves and stay in the game, and maximize our upside over the long-haul.

I guess that makes sense, so what makes a stock move up or down?

In the long-term, a stock will always move in unison with the success of the company, driven by its revenue and earnings. This is undisputed. The success of the stock market over time is a tribute and reflection to companies growing and expanding over the long-term, which drives up their stock price, which if part of an index in turn, collectively, drives up the index. Think of the Dow Jones Industrial Average or the S&P 500.

However, in the short-term, there are many inefficiencies that come into play with a stock which an investor or trader can exploit. Did you know that every stock has a different amount of shares outstanding or float (shares available to the public)? Smaller companies generally have a much smaller float than a larger one. The smaller the float, the easier it is for the stock to move up or down. Smaller names also trade a smaller daily volume than their larger brothers. They are also, lesser known, aren’t talked about as much, and have less prying hands in them (minimal manipulation), which we like. Short-term inefficiencies or anomalies allow us to capitalize on stock charts moving up and down.  These movements happen all the time, over and over, regardless of what the company does and they form what are called chart patterns. And the screening, recognition and selection of these chart patterns is how we can profit from the market’s movements.