Stockology

Technical analysis is the topic for today. I mentioned in the previous post that it would be impossible to cover every aspect of technical analysis in a blog, not to mention one post in a blog. But I’ll do my best to go over some more common indicators and ones I use on a daily basis.

First of all, a stock chart is a chart that tracks the price of a stock. So if you were to look up Microsoft’s chart on Yahoo! Finance or something, the chart would show Microsoft’s stock price plotted out on a chart. As far as aesthetics are concerned, there are a few chart types: Line chart, Bar chart, and Candlestick chart. I think the default chart on Yahoo! Finance is a Line chart.

Personally, I use the Candlestick chart. (No particular reason, they all display the same information, just from a different perspective.) Aside from the price, there are a bunch of indicators used on a chart to help identify patterns and whatnot. The most common indicator on a stock chart is the volume indicator. That should be pretty self-explanatory. Volume is usually shown as bars. So each day’s trade will have a corresponding volume bar. If a lot of shares were exchanged on a particular day, the volume for that day would be high.

Say Dell came out with earnings that disappointed Wall Street analysts. The stock price plummeted 10% and volume was unusually high. What could you derive from that situation? (Hint: There weren’t a lot of buyers…)

Another indicator that’s widely used is the moving average. I’m not even going to try and define a moving average in my own words, so here’s the definition from Investopedia.com: A moving average is the average stock price over a certain period of time. You calculate it by adding the closing price of the stock for a number of time periods and divide it by the total number of time periods.

So, to get a 5-day moving average for Apple, you’d add up the closing price of Apple for the last 5 days and divide it by 5. I don’t know anyone who uses a 5-day moving average. I use a 20-day, 50-day, and 200-day moving average. Moving averages are good for identifying trends. If the price of a stock today is higher than the average price of the stock for the last 20 days, it’s gone up. Get it? If the price today is higher than the average price for the last 50 days, it’s gone up!

Some more tidbits from Investopedia.com: Traders watch for short-term averages to cross above longer-term averages to signal the beginning of an uptrend.

Think of it this way, if the average price for the last 20 days is higher than the average price for the last 50 days, the price has gone up! Sounds really simple and kind of obvious, right? The truth is, it is! But because so many people use these indicators, stocks have been known to find levels of support at moving averages when they’re going up, and ceilings at moving averages when they’re headed down. In simpler terms: say the stock of a good company has been going up and up and up. It’s bound to take a breather and come down a little bit before going back up. That breather is likely to be at or near a moving average.

You really have to see it in action to get a better idea of how it works.

The last indicator I’m going to cover today is the stochastic oscillator. It’s a momentum indicator that compares a stock’s current price to a price range over a period of time. There’s a crazy formula that’s used to calculate the stochastic, but I’m not going to get into that…

Basically what it does is indicate whether a particular stock has been overbought or oversold. It’s shown on an oscillator so that you can gauge the stochastic against the stock’s chart. The stochastic is plotted on a chart scaled from 0 to 100. The way I use it is this: When the stockastic is below the 20-, it’s oversold. When it’s above the 80-, it’s overbought. I place my ‘buy’ trades just when the stochastic is breaking out above the 20-, and place my ‘sell’ trades just when the stochastic is dropping out of the 80-.

It doesn’t always work, because an oversold stock can continue to be oversold, but at least it guarantees you buy it at a relatively low price. And vice versa.