Below we will look at  ten popular technical anlalysis tools, ranging from simple tools anyone can draw on a chart through to the more complex computerised ones.  Enjoy!

1: Trend Lines

Trend lines are very simply, a line on a chart.  On a simple bar chart a down trend line is drawn over two or more peaks.  An up trend line is drawn over 2 or more troughs.  Traders and investors will often take price crossing above a trend line as a signal to buy, or price crossing below an up trend line as a signal to sell.

The benefits of trend lines are they are very easy to draw, use and learn, and can get you into and out of trades before other methods. 

2: Moving Averages

A moving average is a plot on a bar chart that shows you the average of the last “x” amount of days, weeks, months or years.  To give you an example, a 50 day moving average would be a line on your bar chart that shows the average of the last 50 days in price.  As the price moves and changes, so does the moving average.

Many traders and investors use moving averages as buy and sell signals, as support and resistance or with another moving average or combination where one crossing above another is a buy or sell signal.  Moving averages have been used as part of many automatic trading systems over the years, and can also be separated into Exponential Moving Averages (EMA) where more weight is given to the more recent data, and Simple Moving Averages (MA).

3: Support And Resistance

Price support and resistance is often used by technical analysts for good reason.  Places where large buyers buy and sell become points of support and resistance in the market due to simple laws of supply and demand (i.e. if there are large sellers at a particular price point, it will be hard for the price to rise above this point).

4: Dow’s Theory

Charles Dow’s theory from the late 1800s was three parts: First that the market moves up and down in three phases, from hope, earnings, to euphoria, then from abandonment of hope, lack of earnings, to despair.  Second is his “higher peaks and higher troughs” theory, which according to Dow constitutes a bull market.  Conversely, lower peaks and lower troughs in price would constitute a bear market.  And lastly, the Dow Industrials average and the Dow Transports average ideally make new highs at similar times.  If the Industrials average makes a new high but the Transports does not, it indicates to Dow that there is not as much demand for the goods being manufactured.

5: Fibonnacci Numbers

Leonardo Fibonacci, the Italian economist who introduced the decimal number system to Europe in the 1200s, also invented a number series that was found all throughout the universe: in nature, cells, economics, and life.  The numbers are found by adding the last two numbers in the sequence together, for example: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, and so on.  Dividing these numbers by one gives you a series of percentages, and Technical Analysts around the world have found that the market tends to find support and resistance in the future at and around these percentages!

6: Elliott Wave Theory

Taking Fibonacci and Dow’s Theory one step further was Ralph Elliott, an accountant who became ill and bedridden late in his life, and turned his attention to the stock market.  He formed a theory that consisted of five moves or ”waves” upward, and three waves down.  The theory followed closely what Charles Dow had discovered nearly 50 years before, however Elliott now added the Fibonacci percentages to his analysis, allowing him to “predict” future turning points in the stock market based on the price action.

7: Candlesticks

Munehisa Homma was a very successful rice trader in Japan during the 1700s, generating over 100 billion dollars of profit in todays prices.  He formed a theory for trading and analysing the market which has become known as candlestick charting.  There are more than 20 candlestick “patterns” that evolve in the market, and many more ways to trade with them.  The main draw card for new traders and investors is the way the price is drawn, with a thick body coloured either black or white depending on which way the price closes.  As the picture shows, the bars look like candles, hence the name.

8: Highest Highs, Lowest Lows

While not so much a theory in itself, using a highest high of the last ”x” days (or weeks, months) has been used independantly by many great and successful technical analysts, especially in the areas of Trend Following and Automatic Trading Systems.  Richard Donchian pioneered one method that used four week highs and four week lows to buy and sell.  William O’Neil of Market Wizards fame also used a 52 week high signal as a part of his trading and investing, all with great success.  Using highest highs is also very easy to program and optimize for automatic trading system use.

9: Relative Strength Index (RSI)

 The Relative Strength Index is an “Oscillator” that is used to measure the rate of change in price.  It compares market up days and market down days within a specified period and indexes the results between 0 and 100.  The result is, over “x” periods, how many days finished with a closing price above the previous trading day compared to how many days finished with a closing price below the previous trading day. 

People who use the RSI often use 30 and 70 as triggers for “oversold” and “overbought” levels.

10: Stochastic

The Stochastic indicator is a momentum oscillator that compares the latest closing price of a security to the lowest low and highest high over a given period.  The resultant figure is called %K, and is displayed as a solid line.  Then %D which is a 3 day Simple Moving Average of %K, and often used as a slow stochastic or as a basis for crossover signals with %K.

Like the RSI, the Stochasic will oscillate between 0 and 100, and levels above 80 or below 20 are often used as “overbought” or “oversold” levels.

11: Parabolic Stop And Reverse

The Parabolic SAR is a trend following indicator that is often used to identify entry and exit points, including a stop loss and trailing stop loss as the trade unfolds.  As the parabolic SAR moves up with the price it provides the perfect trailing stop loss.  Once the stop loss is hit, the Parabolic SAR reverses and now gives a stop loss on the top side of price.  The Parabolic SAR is useful in trending markets, and often used in trend following automatic trading systems.

12: Bollinger Bands

Invented by John Bollinger in the 1970s just as computers were making their way into finance, Bollinger Bands consist of a moving average, and then a moving average above and below it (usually “x” standard deviations above and below the middle moving average).

What this does is give a “band” that price often moves within.  If price is nearing or touches the top of the band, it is considered likely to fall to be back within the band.  Likewise, price nearing or touching the bottom of the band is considered more likely to rise to be back within the confines of the band.  Bollinger Bands also act as a volatility measure, naturally widening during times of high volatility, and shrinking during times of consolidation.

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What Other Technical Analysis Tools would YOU add?  What Do You Use?  What Works For You?

Leave your comments, questions or experiences in the comments section below.

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Below is a “cheat sheet” for chart patterns and what they can mean for your trading.

1: Rising Channel

A channel on a price chart is often a sideways consolidation move.  It means that prices are trapped between two values, where people aren’t willing to pay any less or any more.  A rising channel is a rising consolidation mostly seen in a downtrend (but occasionally at the end of an uptrend) that often leads to lower prices.

2: Falling Channel

A falling channel is the reverse of the rising channel.  It consists of slightly downward and sideways movement and is most often seen as a momentary pause in an existing up trend, or occasionally at the bottom of a down trend.

3: Continuation Patterns (Flags, Triangles, Pennants)

Other sideways movements on a chart consist of triangular patterns and rectangular patterns, known as flags or pennants.  These patterns are similar to the channels in that they are a consolidation of price (sideways movement), yet different in that they often simply move sideways, not up or down.  The most common move when price breaks out is a continuation of the previous existing trend.

4: Head and Shoulders Pattern

A head and shoulders pattern consists of a small peak, followed by a higher peak, followed by a lower peak.  The result is a pattern that looks like two shoulders and a head.  Often there is a level of support below all these peaks called a “neckline”, and the most common way traders use this pattern is to expect lower prices when price goes below this neckline.

5: Inverse Head and Shoulders

As the name suggests, it is similar to the head and shoulders, but the opposite.  In other words, there is a small trough, a large trough, then a higher trough.  The pattern is the same in that there is a “neckline” or resistance above these troughs, and if price goes above this it is seen as a signal for higher prices.

6: Broadening Wedge

The broadening wedge, one of my personal favorites, is most often seen on the All Ords index.  It consists of lower troughs, but at the same time higher peaks, resulting in a trumpet like pattern.  The most common way this pattern unfolds is with three peaks and three troughs at the top of a trend.  If price starts to move down after the third peak, lookout.  It is common for price to move down through the bottom of the broadening wedge very sharply.

Again very common is the fact that price will often react strongly to the upside after this sharp down move.  And finally in many cases, a prolonged bear market will follow this sharp upward reaction.

There is not a lot of information on these patterns, suffice to say that I have experienced them over many years on the All Ords in Australia.

7: Dead Cat Bounce

Following on from the broadening wedge is the dead cat bounce, which explains the reaction to the broadening wedge perfectly.  A dead cat bounce is a sharp fall followed by a “bounce” upwards in price.  The bounce often turns out to be false, however, as price resumes the downtrend shortly afterwards.

Notice this sounds very similar to the way prices reacted in the broadening wedge.

8: Cup and Handle

The Cup and Handle is a pattern that evolves as a large trough followed by a small trough, with price breaking out to the upside.  Obviously this looks like a cup with a handle, hence the name.  The pattern often emerges on daily bar charts, and the idea co-incides with other technical analysis ideas, mainly those of higher troughs leading to higher prices.

9: Double Top / Double Bottom

The double top and double bottom consist of two peaks (or troughs for a bottom) peaking at around the same price before falling away again (or rising in the case of a double bottom).  The idea behind it co-incides with other technical analysis ideas like natural price resistance at a certain level, where there are more sellers than buyers causing the price to fall.

Other variations also include Triple Tops and Triple Bottoms, where three peaks or troughs converge instead of two.

10: Gaps (Breakaway, Measuring, Exhaustion)

A Gap in the market is where price opens above the previous day (or weeks) high, or below the previous day’s low resulting in a gap in price on the chart.  Gaps in the market come in three main forms, the Breakaway Gap, the Measuring Gap, and the Exhaustion Gap.

A breakaway gap is often seen at the beginning of a trend (i.e. near the bottom of an up trend), a measuring gap is often seen in the middle of a trend, after the breakaway gap.  An exhaustion gap is often seen at the end of a trend, or after a trend has been in progress for some time.

The Japanese call gaps a “window” in candlestick charting, and many Japanese traders believe that a window must be closed (i.e price must go back to close up the gap) before moving on.

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The likes of Benjamin Graham, Phil Fisher, Warren Buffett have all used and advocated the use of company statistics and fundamentals in their investing success.  Below are ten popular fundamental analysis tools, and what they mean.  Enjoy!

1: Dividend Yield And Franking Credit

The dividend yield is the amount the company has paid out as a dividend percentage over the last 12 months.  A great piece of information for people who invest for yearly income, the most common dividend yield is between 2% and 7% when a company has one.

Also in this information is the company’s franking amount.  As a company often pays tax on its earnings (at around 30%), often this amount can be offset when they distribute a dividend, by way of a franking credit.  A company with 100% franking, for example, can give you the full 30% credit against the dividend payment on your next tax return.

2: Earnings Per Share

The Earnings Per Share or EPS is how many cents the company earns per share.  For example, a company with an EPS of 120 will have earned 120 cents or $1.20 for each share in the last 12 months.

This is a good measure to see if the company is earning its way effectively.  Obviously, the higher a company’s earnings relative to its share price, the better buy it may be.

3: Earnings Per Share 1 Year Growth

It is good to see a company with solid earnings per share, but we also want our company to be growing and not going backwards.

Therefore, a company with a good EPS 1 Year Growth percentage is a good thing to look out for.  Obviously one that is growing at 50% might be a better buy than one that is growing at only 5%.

4: Cashflow Per Share

Cashflow is often used to gauge a company’s performance, and has been referred to as the life blood of any business.  Many analysts believe that it is easy to manipulate earnings per share, but much more difficult to manipulate the cash on hand.  Also, if a company does not have enough cash on hand to support its operations, it is more likely to become insolvent.

5: Cashflow 1 Year Growth

As it is important for a company to have ample cash on hand, so too it is important to see that the cashflow of a company is growing.

6: Price to Book (PB) Ratio

The Price to Book ratio is the price of the share relative to all of the company’s assets.  If the P/B ratio is less than one then it is said that the share price is less than that of its combined assets, and a candidate for good “value”.  Of course a Price to Book ratio of greater than one indicates that the market is taking into consideration other factors, like potential future earnings.

A study by a United States account found that investing with the Price to Book ratio alone (less than 1) yielded a success rate of 44% wins overall.  However the annual return on those wins was so great that it made up for all the the companies that went down and resulted in a stunning annual performance of 23% p.a. over 20 years.

7: Price to Earnings (PE) Ratio

The Price to Earnings Ratio is one of the best known financial ratios in Fundamental Analysis.  As it is the price relative to the company earnings per share, often investors will advocate that the lower the ratio the better.

For example, a company with earnings of 20 cents per share, trading at $1.00 per share, will have a ratio of (100 / 20 = 5) five.  Obviously if you could invest in a company that was making 20 cents in the dollar it would be seen as a good buy.  The average P/E Ratio over the years is around 14, and many value investors will go for a ratio of less than 10.

8: P/E Growth Ratio

The P/E Growth ratio or PEG ratio is the P/E of a share divided by its annual EPS growth.  It can be done using the current EPS growth or projected EPS growth.

For example, a company with a P/E of  11 and 39% 1 Year EPS Growth would be: 11 / 39 = 0.28.  It is said that a company with a PEG of 1 is at fair value, less than one would be considered good value, and greater than one would be considered “expensive”.

9: Interest Cover

The Interest Cover is the amount of times a company’s earnings (before interest and tax) covers the interest on their debts.  For example a company that earns 50 cents per share and pays out 5 cents per share in interest on its debts, would have an interest cover of 10.

A negative interest cover is often to be avoided when looking at shares using fundamental analysis, as it may mean that the company is not earning enough to meet its current fixed interest obligations.

10: Debt To Equity Ratio

Often displayed as a percentage, the debt to equity ratio is the percentage of debt to a company’s equity.  For example a company with a debt to equity of 38% will have just that: 38% of debt against its equity.

Obviously some debt is good and healthy, but significant debt can be toxic.  Many investors will look for amounts around 20% to 50%.

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What Else Would You Add? 

What financial ratios or data do you use?  Which ratios do you steer clear of?  Comment below in the comments section.

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Forming A Trading and Investment Plan

So you’ve learnt what the stock market is and the two different ways to analyze a share.  Now what?  Well before you trade and invest in the stock market, you absolutely must have a trading or investment plan.  Amazingly more than 80% of investors do not have a written trading plan before they trade or invest.  In fact, as Jesse Livermore famously said, most investors will risk “half their fortune in the stock market with less reflection that they devote to the selection of a medium-priced automobile.”

But what do we put in our trading plan and how do we form one?  Very simple.  Our first point of call is to determine our rules for buying and selling.  This involves finding an entry and exit rule that you can practice with and test over at least five years of data (and preferably ten or more).  You must then have a method for determining if your plan is currently successful, which our flagship course will show you how to do.

Your trading plan will also show you how much to risk in the stock market at any one time and on any one share. 

Read More: Your Trading Plan And What To Put In It

It Must Be Right For You – Finding The Right Timeframe

When you form your trading and investment rules you must take into consideration the time-frame you are using.  It is no good having rules for day-trading when you are still working full time.  Likewise, it is no good having long term investment rules if you would prefer to be a part of the action every day.

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You might prefer to look at stocks directly, or you might prefer to trust an automatic system you have coded yourself.  Once you know your trading and investment personality, you can choose rules that will suit you. 

Starting Small

Once you have your trading and investment rules and have tested them over five years of data or more, it will come time to put them to work in the real world.  Most people will tell you to paper trade once you have tested your trading and investment rules.  Paper trading means to write down your trades instead of putting any money into them at first. Instead of this, I prefer the method of risking very small amounts of money in your trades.  Amounts like $20.00, $50.00 or $100.00 per trade.  This will give you an idea of the psychology of trading as well, as there is now real money at risk.

Going For Gold

Once you have your rules, have tested them, and traded them with ridiculously small amounts of money and found them to be profitable, then you can increase your risk and risk the amount that is right for you in the stock market.  During your trading you will have losing periods and drawdowns, but it is important to remember to risk the right amount and stick to your proven trading rules.

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How To Analyse A Company Share

So now you know what a share is, what a market is, how to buy and sell shares and where to find company information.  Now we have to learn how to analyse all the company information in order to determine if it is a good buy or not.  When analysing a share, there are two things we absolutely must look for:

1: The company price trend

2: The company earnings and balance sheet

Of course there are other very important factors involved as well, such as the direction of the overall market (i.e. are we in a bull market or bear market?).  The reason we’ve included both of these things when analysing a share is that many people start out trying to determine if the company they are buying is a solid one.  After all, if it has good earnings and a solid balance sheet, it should go up right?  Not always.  And that is why we look at the price trend as well. 

All too often a company with good fundamentals will be trending down, losing money for its investors.  And just as often, a company with a terrible balance sheet might rocket to the moon, making thousands for its investors.  This is why is is also prudent to check the trend of a market and company share before investing.

Two Schools Of Thought

This results in two schools of thought in the stock market: fundamental analysis and technical analysis.  There have been many successful investors throughout history who have used both type of analysis, so there is no single right way to analyse a share.  The key is to find the method that works for you.  Here we look at the two methods and how they differ.

Fundamental Analysis:

Looking at a company’s earnings, debt, assets and liabilities is called fundamental analysis.  Your stock broker will have this information for you to view, either online of via their broker reports.

The idea behind fundamental analysis that by buying companies with a strong balance sheet, solid earnings, and controllable debt, the share price is more likely to go up.  Buying strong companies is good in theory, but fundamental analysts must be aware that even strong companies can go down in price when other factors are involved (like a bear market, for example), and often a company’s earnings results are made public long after other investors have sold the share causing it to fall.

Read More: Fundamental Analysis Cheat Sheet: A List Of Popular Fundamental Tools

Technical Analysis

Looking at a companys price history and volume is called technical analysis.  The most common way to do this is with a price chart, which shows the history in price of a company or market.  Often you can see years and decades of history for a stock in a price chart, which allows you to test your technical analysis theories to see if they work.

The idea in technical analysis is to identify patterns or tools that give you a high probability that the price will continue upwards.  Examples of this would be price crossing above a trend line, or a moving average as a signal to buy.  Practitioners of technical analsysis should be aware that nothing works 100% of the time: it merely gives you a higher probability of success.

Read More: Technical Analysis Cheat Sheet: A List Of Popular Technical Tools

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