Technical Analysis of Stocks (Part 2)

Share:

In the previous part, we talked about the basic aspects of technical analysis and about the simples candlestick patterns and the trends they form. Now it is time to proceed to more advanced techniques.

VOLUME Indicator

It’s not about liters or gallons, of course. Volume is defined as the number of shares, or contracts traded, whether for a security or an index, during a given period of time frame, usually an hour, a day, a week, a month, etc.

Volume tells the strength or weakness of the price movement. The greater the volume, the more active the stock is, that’s why it's advisable to trade in a stock where the volume is high. For example, if an up or down price movement is accompanied by high volume, the move can be considered strong.

On the chart, the volume indicator looks like a set of vertical bars at the bottom of the chart, each of them corresponding to a candlestick. The higher is the bar, the higher is the volume on that particular timeframe.

In the previous chart, we saw the trend on the chart of AMD which had one false and one true break-outs. Let’s take the same chart again but add also the volume indicator. This way we could easily see that the false break-out was not accompanied by any un-usual volume, while the true break-out came together with an above-average selling volume.

Volume indicator on AMD technical chart
Volume indicator on AMD technical chart

Whatever your preferred indicator is from the list below, it is very useful to use it together with the volume indicator. This is because volume might save you from fake breakouts.

MOVING AVERAGE

Moving average is a popular technical indicator used by traders. It helps to identify buy or sell opportunities. It is basically an average of the closing price in a given time frame.

Example: 9 Day moving average is the average closing price of the last 9 days. Similarly for 20, 50, 100 days.

If the price is above 200 Day moving average, it is considered the stock is trending.

One could look for a BUY opportunity when the stock is trading above 50 Day moving average or look for a SELL opportunity when trading below 50 MA.

The Moving Average term is also often vehiculated as “SMA”, which stands for “Simple Moving Average”. As you will learn later, there can be also other types, besides the “Simple” one.

Representation of a 50-Day Moving Average on a stock chart
Representation of a 50-Day Moving Average on a stock chart

MOVING AVERAGE CROSSOVERS

Based on intersections between moving averages, we can judge a trend reversal. For this, we need to use 2 SMAs with different periods, one longer and the other shorter.

As a rule, if the shorter-term moving average crosses the longer-term moving average from below to above then it is considered as a BUY signal. In contrast, if the shorter-term moving average crosses the longer-term moving average from above to below, it is considered a SELL signal.

Moving Average crossovers
Moving Average crossovers

In this simple form, the moving average crossovers are not used too often. Therefore, it is not worth saying more words about it, so let’s move to the most used application of this concept.

MACD, Moving Average Convergence Divergence.

Imagine how fine would it be if you were able to identify the attenuation and price stabilization after a down-trend so that you can “jump on” the stock at rock bottom.

You could make the search of such patterns by the naked eye, however, a much more professional approach is to use the MACD indicator, which is a much more sophisticated usage of the moving average concept.

As per Investopedia definition, “MACD is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The result of that calculation is the MACD line.

Then you have to add to the MACD line a 9-Day moving average (“signal line”), which will serve as BUY or SELL signal.

Quite simple, right?

Before giving that up, you have to know that fortunately the brokerage tools or TradingView platform provide an easy-to-use feature that adds everything automatically.

The picture below will bring even more clarity:

MACD example
MACD example

The indicator can be added to the chart just by a couple of clicks, you have to wait for the respective signals, which occur when the MACD line and the signal line intersect.

It is quite simple, indeed.

RSI — Relative Strength Index

RSI is a very popular indicator developed by J. Welles Wilder, which is a leading momentum indicator that helps in identifying trend reversals. The objective is to identify the overbought or oversold areas.

The indicator can oscillate between 0 and 100 and the number will rise as the number and size of positive closures increase, and it will fall as the number and size of negative closures increase.

A value above 70 indicates the stock is overbought, while a value below 30 indicates it is oversold.

RSI example
RSI example

The actions to take are clear — buy when the stock is oversold, and sell when the stock is overbought.

As in the case of MACD, the RSI indicator can also be added to the chart quite easily, just with a couple of clicks.

BOLLINGER BANDS

Introduced by John Bollinger in 1980, it also tells you about the Overbought and Oversold areas.

A trader will try to SELL when the price reaches the top of the band and will execute a BUY when the price reaches the bottom of the band.

It has 3 components:

The middle line — 20 Day moving average

The upper band — acts as a resistance line

The lower band — acts as a support line

The upper and lower bands are constructed by evaluating the Standard Deviation of the stock and adding/subtracting that from the 20-Day Moving Average. In other words, they represent how much the stock is expected to deviate, considering its standard behavior.

Bollinger Bands example
Bollinger Bands example

Similar to the previous two cases, the Bollinger Bands can easily be added to the stock chart by using the tools available on your brokerage platform or TradingView.

You can also watch the video below, which will provide additional information, but also will show you in real-time how to set up some of the above indicators.

Conclusions

I hope the information you got from this article will be useful for you in your trading activity.

You can see applied examples of technical analysis in our section called “Behind the Charts

Please keep in mind that these are just speculative methods to determine the stock price movements and they cannot account for many other factors, including the fundamentals of the particular companies.

Neither shall this article be considered as investment advice. Everything exposed here is only for informative purposes and you shall perform your own analysis before taking any risk on your own.

I kindly invite you to share your comments, suggestions, or questions in the comment section.

You can see the original article here:

https://www.art-invest.net/post/technical-analysis-of-stocks-part-2

Happy trading to all of you,

Alex Artenie