In a previous article I wrote about trends and why they matter so dearly to traders and investors alike. With a solid understanding of trends, a market player can utilize other forms of analysis to make money. After all, that is why we play the game isn't it? There are basically two schools of thought in the terms of market analysis. The two being technical analysis and fundamental analysis. Many are divided over which reigns supreme over the other, but I strongly believe both are equally necessary for optimal, long lasting, success. Though, if I were suddenly thrusted into the frontlines and could take one I'd get technical, technically speaking. The reason being that while fundamental analysis tells you which companies are sick and which are healthy, technical analysis informs the individual whether the price is going up or down. That being the case, let's dig a bit deeper into what I, and many others, consider to be four of the best technical indicators.
Volume Measures liquidity and is believed to be key in indicating trends and trend reversals. Liquidity is important because without enough people trading a particular security it can be quite difficult to get in and out of a trade. Volume from different time periods are compared in order to get a relative indication of what is high, low and average. When compared with price levels, you get a much better grasp of what's going on and where a given stock, index, commodity etc. is headed. According to Dow Theory, volume should increase when prices move in the direction of the trend. The opposite is also believed. That being volumes decrease with prices moving against the trend. This is important. More often than not this is a tell tale sign that a trend is about to end. A trend reversal may be in place, but many times the market will simply trade in range.
"But Michael, can volume alone tell me when a trend is ending?"
Price, Support and Resistance
Volume tells a lot or the story, but price in conjunction with support and resistance are vital to any analyst worth their salt. Support and Resistance are lines on a chart that are drawn at specified price levels. When prices are in a down trend, the support line is where the price is not expected to pierce. A floor if you will. Resistance lines serve as an anticipated ceiling. A share price isn't expected to fly much further past this milestone. In a perfect world this would conclude the articles portion of Support and Resistance, but this world is by no means perfect and technical analysis is all theory. If and when Support and Resistance lines are penetrated their respective roles reverse. The previous support becomes the new resistance line and that old resistance becomes a support barrier. All instances mentioned have MUCH to do with investor/trader psychology or what is also known as market sentiment (A topic for a later date).
In practice, I believe it is most efficient to use past price patterns (say THAT three times fast! :-P) to draw Support and Resistance lines and to observe volume closely as the price approaches these levels.
All in all, there are many, many technical indicators and fancy oscillators out there (many of which are very useful), but anyone who is serious about technical analysis and wants to make money online via stock market, commodities markets, the forex currency exchanges or whatever; must first develop a firm understanding of price and volume patterns and support and resistance lines. Till next timeâ€¦