Researching stocks using technical analysis for short term trading can be a very profitable one. Technical analysis works because investors and traders think it works, therefore it is the psychology of this behavior that ensures technical analysis has the legitimacy. The key is to use a very few technical indicators as opposed to learning a huge array of indicators as propagated by experts. Put simply, it is better to get to grips with the most common and reliable ones rather than putting equal emphasis on the less meaningful ones.
Experts will tell you or you will see promotions of technical analysis ’systems’ that allows a stock’s price to be conveyed via a multitude of indicators, some of which you will never have heard before. However, it is better to rely on the few popular ones that tend to work.
This is very important for a technical analyst because stocks never go in one direction whether up or down, indefinitely. Soon or later they will start range trading. This is when they settle and start trading between two sets of prices, a higher and a lower one. The figures are not absolutely specific, but are quite narrow in range; an example would be a stock that has been bound between $24-26 for some time and cannot breakthrough either direction. A trader is able to profit by buying when the stock approaches the lower (support) end of the range and conversely, shorting when it approaches the high end (resistance) of that range. Of course, the trader will have to study the stock’s chart to confirm that it indeed has been range bound and that the likelihood is that it will remain. Anyhow, the trader will provide himself with support by placing an automatic stop-loss of say 10% in either direction in case it goes against him and breaks out of this range.
These display a stock’s price average over past periods usually on 20, 38, 100 and 200 day being the more popular ones to analyse. The shorter the period the greater the volatility in the price movement. By using an average of prices, moving average smooth a data series and makes it easier to spot trends. This is especially important in highly volatile periods markets, where the moving average allows the user to see the trend more clearly. However, moving averages are lagging indicators in that they follow the stock because they are the average of past closing prices. But since ‘trend is your friend’, it is wise to follow the trend.
RSI (Relative Strength Index)
This is a very useful indicator that warns traders when a stock is approaching a period of being overbought or oversold. However, it may not be wise to trade a stock simply on those terms. If a stock reaches an overbought situation, it may continue to be overbought for a little while longer, so it is better to use this indicator in conjunction with another i.e. if a stock becomes overbought in a range bound situation described earlier i.e. reaching resistance levels of a range, it will likely work much better.