From the very beginning, I have been fascinated with the study of technical analysis. As it turns out, my journey into investment portfolio management began with John J. Murphy’s book, Technical Analysis of the Financial Markets. I cannot recall ever making a trade without reviewing the technical indicators beforehand. Regardless of whether you live in Simi Valley, Thousand Oaks, Moorpark, or Calabasas; I believe investors can benefit from a working knowledge of technical analysis. Let’s begin with a review of what technical analysis is and briefly review a few common technical indicators. So, what is technical analysis?
Technical analysis is the process of forecasting price movements of individual securities, market sectors, and markets like the S&P 500 by analyzing variables such as volume and historical price movement. Technical analysis is based on the premises that market action discounts everything, prices move in trends, and history repeats itself. However, there is no assurance that these movements or trends can or will be duplicated in the future. Let’s review each assumption:
1. Market action discounts everything – The belief is that anything that could potentially affect the price either fundamentally (earnings, dividends, etc.), politically, psychologically, and the like – is already reflected in the price of that market or security. Basically, current prices fully reflect all information.
2. Prices move in trends – The belief is that price movements are not totally random and there are instances when prices trend. The technician believes that it is possible to identify these trends early enough to profitably invest from them.
3. History repeats itself – The study of technical analysis has over 100 years of price movement research, i.e. collective trading psychology. Technicians believe certain chart patterns are recognizable and provide insights into probable investment management outcomes.
It is said that the fundamentalist studies the cause of market movements, while the technician studies the affects. Thus, the technician is only concerned with the affect not the cause or reasons for price movements. Technical analysts focus on the following questions:
- What is the price?
- Where has the price been?
- Where is the price going?
Now that we have reviewed the basic tenets of technical analysis, let’s review a few commonly used indicators.
Relative Strength Index (RSI)
The RSI was developed by J. Welles Wilder, Jr. and presented in his 1978 book, New Concepts in Technical Trading Systems. A reading of the original work by Wilder himself is recommended for a more in-depth understanding. The RSI basically measures the speed and change in price movements. RSI fluctuates along a vertical scale range of 0 to 100, with a reading of over 70 considered overbought and a reading below 30 considered oversold. A good online explanation of the RSI can be found here.
Moving Average Convergence-Divergence (MACD)
The MACD was one of the very first technical indicators I studied. It was developed in the late seventies by Gerald Appel. It is constructed of two exponential moving averages that help measure price momentum in a security or market. Simply, The MACD is the difference between these two moving averages plotted against a centerline.
MACD = shorter term moving average – longer term moving average
The general idea behind the MACD is to measure short-term momentum compared to longer term momentum in hopes of understanding current direction of price momentum. A more thorough explanation of the MACD line can be found here.
Technical analysis can provide insights into the collective psychological aspects of past, present, and future potential price movements of markets or securities. Should you wish to learn more about technical analysis and how it can benefit you in your investment portfolio management decisions, please don’t hesitate to contact me directly at (805) 558-8497 or at firstname.lastname@example.org.
Investing involves risk including possible loss of principal.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The S&P 500 index is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.
No strategy assures success or protects against loss.