Many books have been written on the subject of technical analysis. There are extremely complicated methods and some very simple methods used successfully and unsuccessfully. It has been the subject of many a debate among students. This is so often true of art, which technical analysis is more of than a science.
The reality of the market is that it is driven by emotion and it can be quite irrational. During times of great uncertainty a stock can drop after a great earnings report. On any given day you can find people making a case for an equity to go up and people making a case for that same equity to go down, that is what makes a market. Eventually, fundamentals will win out and all equities return to a rational value, the market determines what that value is. So in the end it comes down to supply and demand, sellers and buyers.
When performing technical analysis it is important to note earnings dates and any dividend dates. Earnings dates are a reset for fundamental as well as technical and sentimental. Many equities will have a pattern going into earnings and follow patterns between ex-dividend dates.
A common set of indicators used at OptionsANIMAL are the 5/20 EMA, the RSI and MACD. In general, when the 5 is above the 20 a stock is bullish, when the 5 is below the 20 a stock is bearish. When the RSI is above the 50 line the stock is bullish and when it is below the 50 a stock is bearish. When the MACD histogram is above the zero line a stock is bullish and when it is below the zero line the stock is bearish. When all three indicators are bullish at the same time there is a good chance that the equity will stay bullish for a time. When all three are bearish there is a good chance that the equity will stay bearish for a time. The RSI may also signal a top or over bought when it is at 70 and over sold or a bottom when it hit 30.
There are stock patterns that can signal a trading opportunity. A popular one is a gap in price that is accompanied by higher than normal volume. Many stocks will follow through in the direction of the gap. Some will not though so past gaps should be studied for each equity to determine how they typically trend. For some equities a gap down with volume can be a great buying opportunity.
Studying past charts for an equity can be very useful to predict future price movements. Studying how accurate various indicators have been in the past can help with determining how accurate they might be in predicting the future. Indicators can be “tuned” to an equity to improve their predictive abilities. Some equities will stop going up when the RSI hits 70, others push up to 80 and other still push to 90. The same is true on the down side. Picking the level that is the most consistent for your equity. Often indicators work best during certain parts of the year.
Studying past charts can also be very useful for determining the best times of the year to trade an equity. They can also be useful for setting support and resistance. An equity may be at its lowest price level about the same time each year. Some equities will trade in a range through the summer, finding their strongest support in late May to early June. They find their summer top in July. These support and resistance levels can be very helpful when determining the best trade to use and the best entry for a trade.
Strong patterns that repeat can be very profitable. Look for equities that run up in to their earnings and which earnings has the strongest move. There are equities that have strong December earnings and weak March earnings. You may find equities that always go bullish August to December. You will find equities that very often run up into their ex-dividend date. There are equities that gap down on ex-dividend and rise from there. You may find other patterns that can be traded, if you look for them. My favorite is a price level that an equity just will not stay below and a price level that it will not stay above.
All that checking of charts must be accompanied by the right market sentiment if the chart is going to repeat. When checking past charts for an equity also check the VIX and a major market index for the same time period. Checking the put/call ratio can also be used to check the market sentiment. The higher the ratio the more fear is in the market. Fear can be caused by uncertainty and/or by fundamental weakness.
If the fundamental, sentiment and technical all line up, you can have a strong move in the market which you can trade using options no matter what direction it is.
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