I get asked a lot what it means to “use technical analysis to find a trade” in the stock market. There are actually many ways to answer that question because there are many ways of using TA as a tool. Here I’ll focus on how I like to use it.
At a minimum I think TA is very useful as the first step in the process of finding a trade by narrowing the field. There are too many stocks out there to manually consider them all, perhaps unless you’re a full-time trader. TA can act as the initial filter, bringing the list of stocks down from say 20,000 to 100 or 10. That’s a much more manageable number.
How does that filtering process work? It’ll be based on applying one or more technical indicators to the stock market. An indicator can be any numerical measurement related to a stock. Example indicators:
- Price dropped >= 5% today
- Price below the 50-day moving average
- Volume is much higher than normal
- Any of the well-known indicators like MACD, RSI, Bollinger Bands, etc. These are all numerical measurements, often comparing the current price with recent price history
Running any of these on the whole market should return a smaller set of stocks that meet the requirements of the indicator. From this list a trader can evaluate each stock and see why it showed up there. For example, did the price drop by 10% because it’s recent earnings report dropped by 10%? In that case the price adjustment seems fair. Or, maybe the price dropped by 10% because a few other stocks in the same industry showed bad earnings. If this one recently met it’s price target perhaps it was unfairly penalized and will quickly jump back up once people get over their emotional panic about this industry.
The holy grail of most technical analysts would be a a buy and sell “strategy” (combination of indicators and trade timing logic) that’s so reliably successful it can trade on it’s own without human interaction. I’m not sure how many times this has been achieved, or even whether it’s feasible over the long-term, but it’s definitely fun trying to get there.
Dayvejohnson on the Markets – Interesting trading log and TA/market commentary.
Wall St. Warrior – Analysis of potential trade ideas.
Trader Mike – Analysis of potential trade ideas and market commentary.