Technical Analysis Indicators and Patterns
When glancing at charts the untrained
eye may simply see random movements from one day to the next. Trained
analysts, however, see patterns that are used to predict future movements
of stock prices. There are hundreds of different indicators and patterns
that can be applied. There is no one single reliable indicator, but
when taken into consideration with others, investors can be quite successful
in predicting price movements.
Patterns:-
One of the most popular patterns is Cup and Handle.
Prices start out relatively high then dip and come back up (the cup).
They finally level out for a period (handle) before making a breakout
– a sudden rise in price. Investors who buy on the handle can
make good profits.
Another popular pattern is Head and Shoulders. This
is formed by a peak (first shoulder) followed by a dip and then a higher
peak (the head) followed again by a dip and a rise (the second shoulder).
This is taken to be a bearish pattern with prices to fall substantially
after the second shoulder.
Indicators:-
Moving Average
The most popular indicator is the moving average. This shows the average
price over a period of time. For a 30 day moving average you add the
closing prices for each of the 30 days and divide by 30. The most common
averages are 20, 30, 50, 100, and 200 days. Longer time spans are less
affected by daily price fluctuations. A moving average is plotted as
a line on a graph of price changes. When prices fall below the moving
average they have a tendency to keep on falling. Conversely, when prices
rise above the moving average they tend to keep on rising.
Relative Strength Index (RSI)
This indicator compares the number of days a stock finishes up with
the number of days it finishes down. It is calculated for a certain
time span – usually between 9 and 15 days. The average number
of up days is divided by the average number of down days. This number
is added to one and the result is used to divide 100. This number is
subtracted from 100. The RSI has a range between 0 and 100. A RSI of
70 or above can indicate a stock which is overbought and due for a fall
in price. When the RSI falls below 30 the stock may be oversold and
is a good time to buy. These numbers are not absolute – they can
vary depending on whether the market is bullish or bearish. RSI charted
over longer periods tend to show less extremes of movement. Looking
at historical charts over a period of a year or so can give a good indicator
of how a stock price moves in relation to its RSI.
Money Flow Index (MFI)
The RSI is calculated by following stock prices, but the Money Flow
Index (MFI) takes into account the number of shares traded as well as
the price. The range is from 0 to 100 and just like the RSI, an MFI
of 70 is an indicator to sell and an MFI of 30 is an indicator to buy.
Also like the RSI, when charted over longer periods of time the MFI
can be more accurate as an indicator.
Bollinger Bands
This indicator is plotted as a grouping of 3 lines. The upper and lower
lines are plotted according to market volatility. When the market is
volatile the space between these lines widens and during times of less
volatility the lines come closer together. The middle line is the simple
moving average between the two outer lines (bands). As prices move closer
to the lower band the stronger the indication is that the stock is oversold
– the price should soon rise. As prices rise to the higher band
the stock becomes more overbought meaning prices should fall. Bollinger
bands are often used by investors to confirm other indicators. The wise
technical analyst will always use a number of indicators before making
a decision to trade a particular stock.
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