THE
3 BEST
TECHNICAL INDICATORS ON EARTH
This oft-quoted warning also forms the basis for technical
analysis. Only I’d tweak it to say, “Those who do remember
the past are likely to profit from it.”
THAT’S TECHNICAL ANALYSIS IN A NUTSHELL.
After all, technical analysis is based on the idea that all
the information is represented in price and volume. So by
comparing what’s happening in the market today to what’s
happened in the past, you can tell what will (most likely)
occur in the future.
“Those who cannot remember the past
are condemned to repeat it.”
In other words, while fundamental analysis involves screening
businesses’ balance sheets, earnings reports and economic conditions to try to predict stock returns, technical analysis relies on the participants in the market to distill all that information into meaningful data.
And by watching price and volume, you can interpret the emotions driving the market.
Some believe that technical analysis is simply about drawing lines on a chart – and that it’s essentially the equivalent of financial astrology.
Hogwash!
Granted, some methods have failed to produce real returns. And I agree that not all technical indicators are worthy of your attention.
That’s why it’s important to focus only on the key indicators that have proven successful – time after time.
Lucky for you, we’ve found the top three, best of breed, technical indicators that you can use to maximize your profits. Here’s a brief rundown of each…
INDICATOR #1:
MOVING AVERAGE CONVERGENCE/
DIVERGENCE (OR MACD)
The MACD indicator is a great introduction to technical analysis because it’s based on one of the easiest, most powerful concepts: the moving average.
Calculating and drawing a moving average line is simple. It’s just the average price of a stock over a number of days, usually 50 or 200.
A stock trading above this line is a strong bullish indicator by itself. But you can take a moving average to the next level by tracking when moving averages of different lengths of time cross paths.
Take a look at the chart for Under Armour (UA) to see what I mean.
When the 50-day moving average crosses above the 200-day moving average, it means the stock is likely going to see a big move higher. Basically, MACD takes moving averages, fine tunes them and combines them into a single indicator. It just takes a few more steps…
1)
First, instead of a 50- or 200-day moving average, MACD uses 12 and 26 days. It also focuses specifically on the “exponential moving average,” which means more weight (and importance) is given to the most recent stock prices.
2)
The next step is creating the “MACD line,” which is simply thedifference between the 12- and 26-day exponential moving averages from step one.
3)
Once that’s done, the “signal line” is created. That’s the nine-day exponential moving average of the new MACD line.If this sounds complicated, keep in mind that you don’t really need to know how the lines are created. The important part is how they interact. Check out the following chart of Bank of America (BAC) to see
what I mean.
There are two main things you need to watch for…
1)
When the MACD line jumps above zero, it shows that the current momentum is positive. And when it drops below zero, momentum is negative.
2)
Most important, you can identify when these shifts in trajectory are likely to occur. It’s all about watching when the lines cross over each other.
When the MACD line crosses above the signal line, momentum is about to turn positive. And when the signal line jumps higher than MACD, it’s a sign that the share price is about to dip.
The chart indicates the bullish points with green arrows and the bearish patterns in red. Sure enough, the stock movements (mostly) correspond with the “Buy” and “Sell” signals.
The trick is to spot the crossovers as close to the zero line as possible. That’s where the strongest signals occur.
INDICATOR #2:
PARABOLIC SAR
Don’t let the imposing name fool you. Parabolic SAR is dead simple to interpret.
SAR stands for “stop and reverse,” meaning that it’s designed to find turning points in stock trends.
In short, Parabolic SAR captures momentum.
The indicator is typically drawn as dots that follow a stock chart. When the dots are below the price, the momentum is positive, like the dots are pushing the stock up. When the dots are above the price, momentum is negative.
In simplest terms, when the dots switch from above the stock price to below, that’s a clear “Buy” signal. On the flip side, when they switch from below the price to above, it’s a “Sell.”
When the MACD line
crosses
above
the signal line, momentum is about toturn
positive
. And when the signal linejumps
higher
than MACD, it’s a sign that the share price is about to dip.You’ll also notice that the dots tend to converge with the stock price right before they switch sides. So the closer the dots get to the share price line, the sooner the current share price direction is likely to reverse.
So not only does Parabolic SAR identify the turning point, it shows how much time you have to invest accordingly.
Simple, right?
There’s one trick to using Parabolic SAR, however. You need to be selective about your “Buy” signals.
You see, if a stock is trading within a narrow range, the dots will give off multiple “Buy and “Sell” signals in rapid succession. That’s not a formula for making money.
When the stock traded in a tight range between June and August, there was a flurry of signals that wouldn’t have been profitable. But between January and March, the signal worked well.
To reconcile this, verify that the overall stock market is trending in a similar direction, too, and not staying stagnant. Of course, you could pair the MACD line with Parabolic SAR to double check your findings.
INDICATOR #3:
MONEY FLOW
We already know there are two sides to every stock trade – the buyer and seller.
But wouldn’t it be nice to know what’s going on behind the scenes? That is, whether the buyers or the sellers are more eager to act? With a stronger grasp of investor sentiment about a particular stock, you could pick your “Buy” and “Sell” levels with more confidence.
That’s what the Chaikin Money Flow tries to capture. It indicates “buying pressure” and “selling pressure.”
The Chaikin Money Flow takes positive and negative periods for a stock, then multiplies them by the volume of trading over that time. This assigns greater weight to days when there was heavy volume. Then it compares the ratio of positive pressure to negative pressure and converts that to a value between -100 and 100 (or between -1 and 1 on some software).
At that point, you chart it as an additional line under the stock. When Money Flow is high, it means the stock has more buying
With
a
stronger
grasp
of investor sentiment about a particular stock, you could pick your“Buy”
and “Sell”
levels with more confidence.
pressure than selling pressure – and vice versa.
Now, you may be tempted to use this as a trend indicator. So you’d buy when there’s a lot of buying pressure.
But Money Flow actually identifies when a stock is overbought or oversold. As a result, it shows the end of the trend (or a reversal point). In other words, it’s more of a contrarian indicator. When the rating is high, it means there may be too much buying pressure and the stock is set to collapse.
On such merits, when the Money Flow passes a critical level (25 or -25 is a good rule of thumb) and stays there for a while, it’s a sign that a reversal is imminent.
(An indicator called the Money Flow Index is very similar to Chaikin Money Flow, with only a slight change in the calculations. You can
www.wallstreetdaily.com
Money Flow Pinpoints When Stocks
Are Due for a Reversal
21 20 19 18 17 16 15 14 13 25 0 25 Source: RightWayCharts.com
Morgan Stanley (NYSE: MS)
Nov Dec 2012 Feb Mar Apr May Jun Jul Aug Sep Oct
www.wallstreetdaily.com
Money Flow Pinpoints When Stocks
Are Due for a Reversal
21 20 19 18 17 16 15 14 13 25 0 25 Source: RightWayCharts.com
Morgan Stanley (NYSE: MS)
interpret the signals the same way.)
Bottom line: Combining these three simple indicators can create a powerful system for identifying when stocks are likely to rise or fall. You don’t need a math degree. Heck, you don’t even need to
understand the formulas to use these indicators to boost your investment profits.
You just need to look at a few charts until you can see the patterns repeating themselves. After all, that’s the basis of technical analysis.
The chart says it all.
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