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What is Technical Analysis?
In its simplest form, technical analysis is the study of price. Of course, you can climb deeper than that but for now, we'll stick with the study of price.
From trendlines to stochastics, oscillators, and other measures of trading activity, technical analysis focuses on patterns of price movements and other charting tools to evaluate a security's strength or weakness.
Why Should You Use Technical Analysis?
Flexibility and objectivity are two of the best reasons that every investor or trader should use technical analysis.
Flexibility because technical analysis can be applied to almost anything, and Objectivity because it focuses on the facts - and just the facts!
Technical analysis uses current and historical data to generate an outlook or signal. This means it can be used on anything, including stocks, futures, commodities, fixed-income investments, currencies, and almost anything else with reliable data.
Typically, you'll hear about technicals on stocks, exchange-traded funds (ETFs), and indices like the S&P 500 or Nasdaq Composite. The bottom line is that once you learn how to use a few basic indicators, you'll immediately improve your odds across almost any security.
When Should You Use Technical Analysis?
The answer here is so simple... ALWAYS!
Another aspect of technical analysis' flexibility is that it works in every type of market. Bull, bear, trading range - everything.
Patterns in prices change, and the fact is that technical analysis allows the nimble investor to adapt to all market conditions.
Through my decades in the business, I've seen multiple bull and bear markets. The main takeaway is that technicals worked every time.
A trend is a trend is a trend. It doesn't matter if the market is going up, down, or sideways... Technical analysis will find the stocks to buy or short in all of them.
And that matters, because...
The Trend is Your Friend
Now we start to get down to my go-to technical analysis indicator, the 50-day moving average (MA50). This indicator is the lifeblood of the technical-analysis world. There is no other trendline that embodies the phrase "the trend is your friend" better.
How do you calculate it? Simple. It's literally the average of a stock's closing price over the last 50 days. That's it. You've likely been doing this type of math since you were in the sixth grade. Remember calculating your grade point average? You've got this. Better yet, you don't have to calculate it thanks to the wonder of technology and all the charting tools you have at your disposal on the internet.
The chart below is a three-year (daily) of the S&P 500 with its MA50.
Here's a simple application. Years ago, I performed a laborious (you won't see me pulling $3 words like that often) study on the MA50 of each of the S&P 500 stocks individually. I pulled apart the relationship of this trendline on each stock and found the following simple rule...
When a stock's MA50 is rising, there is a 2:1 likelihood that the stock will move higher. Sim…
About the Author
Chris Johnson is a highly regarded equity and options analyst who has spent much of his nearly 30-year market career designing and interpreting complex models to help investment firms transform millions of data points into impressive gains for clients.
At heart Chris is a quant - like the "rocket scientists" of investing - with a specialty in applying advanced mathematics like stochastic calculus, linear algebra, differential equations, and statistics to Wall Street's data-rich environment.
He began building his proprietary models in 1998, analyzing about 2,000 records per day. Today, that database, which Chris designed and coded from scratch, analyzes a staggering 700,000 records per day. It's the secret behind his track record.
Chris holds degrees in finance, statistics, and accounting. He worked as a licensed broker for 11 years before taking on the role of Director of Quantitative Analysis at a big-name equity and options research firm for eight years. He recently served as Director of Research of a Cleveland-based investment firm responsible for hundreds of millions in AUM. He is also the Founder/CIO of ETF Advisory Research Partners since 2007, noted for its groundbreaking work in Behavioral Valuation systems. Their research is widely read by leaders in the RIA business.
Chris is ranked in the top 99.3% of financial bloggers and top 98.6% of overall experts by TipRanks, the track record registry of financial analysts dating back to January 2009.
He is a frequent commentator on financial markets for CNBC, Fox, Bloomberg TV, and CBS Radio and has been featured in Barron's, USA Today, Newsweek, and The Wall Street Journal, and numerous books.
Today, Chris is the editor of Night Trader and Penny Hawk. He also contributes to Money Morning as the Quant Analysis Specialist.