Understand How Technical Analysis Can Help You Determine When To Buy

Investment analysis can be separated into one of two schools of thought, the fundamentalists and the technical analysts. The fundamentalists analyze the company’s cash flows, industry and everything that goes into the company’s business to determine good investments. Technical analysts believe that investment profits can be made by using patterns in stock prices to determine where the price may be in the future.

Technical analysts generally invest for short-term profits, possibly owning a stock for less than a second. Fundamental investors generally hold onto a stock for much longer periods, maybe never selling the shares. While this site is mostly geared to fundamental investing, and the ultimate effectiveness of technical indicators may be questionable, there is a way to use some indicators to help improve your investment decisions.

Fundamental analysis helps you understand what to invest in, while technical analysis may help to determine when to invest.

What is a Technical Analysis?

At its most basic, technical analysis is the study of price and volume in stocks to establish some pattern. Followers believe that these patterns often repeat, mostly due to human behaviors like fear and greed, and that the watchful eye can take advantage to make a profit.

Volumes have been written on technical analysis and you could spend a career learning the math behind it. Fortunately, most investors really do not need more than a few indicators. Some indicators help to measure the volume of money flow, which is joined with the price direction to determine the strength of sentiment for the continued trend. Other indicators measure the momentum, or direction, of stock prices. Most investors really only need one momentum indicator and one volume indicator to help them determine when to purchase stocks of companies with good fundamental prospects.

The accumulation-distribution line (A/D line) is used to determine the money flow into or out of a stock. It measures the volume of shares traded against the range of prices. If investors are buying into the shares when the price is trending upward then it could mean that there is increasing pressure for prices to go higher. Conversely, if the trend is downward then it could mean that investors are getting progressively more anxious to sell when the price drops.

The A/D line is calculated as the (closing price – lowest price) minus (highest price – closing price) and divided by (highest price – lowest price) times the period’s volume. The measure is a continuous one and just keeps a running sum over a period, usually month to month.

The moving average convergence divergence (MACD) indicator is one of the most well-known and widely used in technical analysis. The indicator is the difference between two moving averages, usually the 12-day and 26-day exponential moving averages, to show the trend and momentum for a stock price. When the MACD is positive, the shorter-term average is above the longer-term average, it suggests that the momentum is for upwards in the price.

Since it is an exponential calculation, you probably won’t be doing this one in your head. Most online investment accounts include easy charting that will show the MACD and other indicators.

Beyond your own online account, StockCharts.com also offers a good review of technical analysis and how to use the indicators. The site includes some indicators in its free charts and is a good place to start if you are just looking for simple guidance on buy-sell points.

The usefulness of technical analysis is widely debated. While good fundamental analysis can help you find solid companies that will give you good returns long-term, the jury is still out on technical indicators. There are traders, along with the bank-owned supercomputers, that do very well using technical signals to jump in and out of stocks for a quick profit. Most investors are better suited using the indicators as longer-term signals of market direction and momentum.