Technical Analysis

Technical Analysis is driven by patterns within historical market stock prices and volumes. It does not apply fundamental data at all on the basis that all factors that influence the price of a stock are already included in past stock prices. These influences include human emotion. Because of this Technical Analysis can provide indicators to likely stock price movements that are impossible to identify using Fundamental Analysis.

Technical Analysis is more art than science and has both converts and critics. It applies a range of mathematical modeling and statistical techniques to determine likely future stock price trends. To some these techniques appear to be valid science, to others simply an attempt at unsupported bedazzlement. Technical Analysis is often used as a black box; feed data in and act on the output; with limited appreciated of the process being applied. However perhaps the best Technical Analysis parameters are the simple ones.

Moving Average


A moving average is simply the average of a previous number of periods. In Technical Analysis it is often used with a market stock price and plotted on a price versus time chart. The purpose of a moving average is to smooth out short term price fluctuations allowing underlying trends to be easily identified. The number of periods used depends on the time frame of interest, the greater the number used the smoother the plot. Moving Averages with different periods provide indicators for short and longer term price movements.

Interpretation


Moving Average is an indicator of underlying trend.

Moving Average is a lagging indicator, the greater the number of periods the greater the lag and the smoother the Moving Average. Shorter term Moving Averages crossing longer term Moving Averages signal a break in the previous trend.

Prices moving above the Moving Average indicate an up trend.

Prices moving below the Moving Average indicate a down trend.

Bollinger Bands


Bollinger Bands indicate price ranges relative to previous prices. They use a moving average as a center line and an upper and lower band each 2 standard deviations from the center line. Usually over 90% of prices will be within the Bollinger Bands, however this is influenced by the number of periods used and the price volatility. Prices outside the bands tend to indicate extreme price fluctuations.

Interpretation


Bollinger Bands are an indicator of stock price volatility.

Bands close together indicate low volatility.

Low volatility indicates a stable trading environment and continuation of underlying trends.

Bands far apart indicate high volatility.

High volatility is an indicator of change; but not necessarily reversal; of underlying trends.

High volatility is more likely to be associated with down treads.

High volatility increases short term trading opportunities.

A price above the top Bollinger Band can be used as an over brought indicator and a sell trigger. A Double Top Sell trigger is when the price goes above the top band and then remains below the top band on following highs. This is confirmed if the price moves below the moving average center line.

A price below the bottom Bollinger Band can be used as an over sold indicator and a buy trigger. A Double Bottom Buy trigger is when the price drops below the bottom band and then remains above the lower band on following lows. This is confirmed if the price moves above the moving average center line.

Stochastic Oscillator



The Fast Stochastic Oscillator uses a %K line which indicates how close the last closing price is to the highest and lowest price for a previous number of periods. A %K of 100% indicates the last price equals the highest price for the period. A %K of 0% indicates the last price equals the lowest price for the period. A %K of 50% indicates the last price is in the middle of the high low price range for the period. When momentum is positive the last price will tend to be closer to the highest price for the period than the lowest. When momentum is negative the last price will tend to be closer to the lowest price for the period than the highest.

A %D line is also included and is a moving average of %K. %D is basically a smoother trailing %K and acts as a trigger line.

Where large fluctuations in price occur the Fast Stochastic Oscillator may exhibit false indicators. To decrease these false indicators and smooth the oscillator a Slow Stochastic Oscillator can be used. The Slow Stochastic Oscillator simply uses a %K which is the moving average of the Fast Stochastic Oscillator %K resulting in a smoother indicator but increased lag.

Interpretation


A consistently high %K indicates positive momentum or buying pressure.

A consistently low %K indicates negative momentum or selling pressure.

%K above 80% signals an over brought level. A sell trigger results when %K crosses down below %D. %K crossing below 80% confirms the sell trigger.

%K below 20% signals an over sold level. A buy trigger results when %K crosses up above %D. %K crossing above 20% confirms the buy trigger.

Money Flow Index


The Money Flow Index (MFI) uses stock price and volume to calculate an indicator of price support.

The calculation considers the value of stocks traded (price * volume) for each day in the period. When the daily price is above the the price of the previous day the money flow is considered positive with buyer support, when it is below it is considered negative with seller support. The Money Flow Index is the ratio of positive money to negative money for the period.

Interpretation


A Money Flow Index above 80% is an over bought indicator, with potential reversal.

A Money Flow Index below 20% is an over sold indicator, with potential reversal.

Price changes not supported by the Money Flow Index may indicate a pending reversal. A rising price without a rising Money Flow Index may indicate a lack of buying support for the higher price and a pending price reversal. A falling price without a falling Money Flow Index may indicate a lack of selling support and a pending price reversal.

If MFI is unavailable; as it is for indexes; the Relative Strength Index RSI can be used and interpreted in a similar manner. The RSI does not consider volume.


For additional detail see Technical Analysis at Wikipedia.