Fundamental VS Technical Analysis Part 2

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At the end of last week we covered the very basics of Fundamental Analysis. We covered what it is in concept and I shared with you a few common, but important, ratios that help make the analysis process a little easier when choosing an investment. Today we are going to cover the other side of the coin and that's Technical Analysis. What Technical Analysis does is it tries to predict the future prices and price trends of an equity based only on passed recorded data. Technical Analysts use past prices, patterns in price trends, volume, the trading environment, and any other piece of recorded data they can get their hands on to try to give them some kind of insight on where the future price of the stock will go. This is going to be fairly brief so make sure you check out this great book put out by Bloomberg called Chart Patterns.

In Technical Analysis there are a few patterns that investors train themselves to identify when sorting through past information. A few of those are:

• Head and Shoulders - This name signifies a reversal in a stocks price where the price trend line bears similarity to a human body from the shoulders up. What I mean by that is as the trend climbs there's a spike in the price then a lull in activity (shoulder), then another spike (head) then it declines to the previous levels before the last shoulder, then a small rally (other shoulder), then falls again. 
• Double Top or Double Bottom - Double Top trends are associated with bearish sentiments and Double Bottom with bullish sentiments. The Double Top resembles a M in its trend line as it reflects the price of a stock rising to a max threshold then selling (first peak), then gaining back to it's last threshold until the price gives out all together. The Double Bottom is the reverse and it's trend behaves similarly but the trend line resembles a W and it's about prices rising not falling.
• Gaps - Gaps have to do with the behavior of an equity right out of the open. Gaps are also refered to as Rising and Falling Windows. The idea here is that if a stock opens at a higher price than it's close the prior trading day then the sentiment around that equity is a bullish one. The larger and longer the gap the better the market feels (increased demand) about that equity. The reverse is true about a Falling Window, it's a gap that is created by when an equity opens below the prior days close.

Technical Analysts don't just use the individual equity's information but try to gather as much about the relevant financial environment as possible to create the best possible forecast. Analysts use relevant futures patterns, what the Forex markets are doing, and domestic and foreign economic data. The idea here is to try to understand why prices behaved like they did in the past and create measures to find when and under what circumstances they will behave like that in the future. There are a few approaches to Technical Analysis and the most common are:

• Candle Sticking - Candle Sticking can be traced as far back as 17th century Japan and attributed to a rice broker named Munehisa Homma who used this method to predict rice prices. The candle sticks come in three variations: a clear body (blue in the pic), a dark or solid body (red in the pic) and a thin body. The clear indicates that a stock closed above it's open that day, a dark is the reverse of the clear and the thin body candle stick means the stock closed at the price it opened at. Based on the overall pattern of the candle sticks, the proximity between the three types of candles, and their relative sizes analysts try to predict where future prices will go.
• Line Charts - This one is pretty self explanatory. It's just a line chart connecting the closing day prices of an equity over a period of time. What analysts do is take other data trend lines and super impose it over the stocks trend line to look for patterns, crossover, or other points of interest and go back to that time to see what caused that behavior. These types of charts are what analysts look for when they are spotting their trends patterns like the ones previously listed.

Technical Analysis is another one of those topics that has entire college courses dedicated to it. If you are curious about it as a way to approach your investment decisions you should definitely do the research. Great analysts spend their life time in this craft and still don't get it right 100% of the time. If you are a DIY'er or have a little skin in the market via an online broker like E*Trade or Zecco they have their own libraries of charts and graphs to delve into. The next time you are looking through those charts take an extra second to not just look at the obvious upward or downward trend but try to find some kind of pattern to it. You never know what you might find. I can't stress this enough too in markets like this, if you are using a online broker and you enjoy your experience with them make sure you take advantage of those affiliate programs - who doesn't enjoy a few extra dollars to trade with. You can even use your new found Technical Analysis prowess!