In its simplest form, technical analysis is the study of price. Of course, you can climb deeper than that but for now, we’ll stick with the study of price.
From trendlines to stochastics, oscillators, and other measures of trading activity, technical analysis focuses on patterns of price movements and other charting tools to evaluate a security’s strength or weakness.
Why Should You Use Technical Analysis?
Flexibility and objectivity are two of the best reasons that every investor or trader should use technical analysis.
Flexibility because technical analysis can be applied to almost anything, and Objectivity because it focuses on the facts – and just the facts!
Technical analysis uses current and historical data to generate an outlook or signal. This means it can be used on anything, including stocks, futures, commodities, fixed-income investments, currencies, and almost anything else with reliable data.
Typically, you’ll hear about technicals on stocks, exchange-traded funds (ETFs), and indices like the S&P 500 or Nasdaq Composite. The bottom line is that once you learn how to use a few basic indicators, you’ll immediately improve your odds across almost any security.
When Should You Use Technical Analysis?
The answer here is so simple… ALWAYS!
Another aspect of technical analysis’ flexibility is that it works in every type of market. Bull, bear, trading range – everything.
Patterns in prices change, and the fact is that technical analysis allows the nimble investor to adapt to all market conditions.
Through my decades in the business, I’ve seen multiple bull and bear markets. The main takeaway is that technicals worked every time.
A trend is a trend is a trend. It doesn’t matter if the market is going up, down, or sideways… Technical analysis will find the stocks to buy or short in all of them.
And that matters, because…
The Trend is Your Friend
Now we start to get down to my go-to technical analysis indicator, the 50-day moving average (MA50). This indicator is the lifeblood of the technical-analysis world. There is no other trendline that embodies the phrase “the trend is your friend” better.
How do you calculate it? Simple. It’s literally the average of a stock’s closing price over the last 50 days. That’s it. You’ve likely been doing this type of math since you were in the sixth grade. Remember calculating your grade point average? You’ve got this. Better yet, you don’t have to calculate it thanks to the wonder of technology and all the charting tools you have at your disposal on the internet.
The chart below is a three-year (daily) of the S&P 500 with its MA50.
Here’s a simple application. Years ago, I performed a laborious (you won’t see me pulling $3 words like that often) study on the MA50 of each of the S&P 500 stocks individually. I pulled apart the relationship of this trendline on each stock and found the following simple rule…
When a stock’s MA50 is rising, there is a 2:1 likelihood that the stock will move higher. Similarly, when the MA50 is trending lower, there’s a 2:1 chance the next day’s price will go lower.
Granted, it’s a simple rule, but it provides the backdrop for simplifying technical analysis.
The actual application, now that’s a little different. You see, technical analysis also has a little hint of art to it. This is why I like to refer to what I do as “harnessing the art and science of the markets.”
Bottom line, if you are an intermediate-term trader, the MA50 will give you a simple view of whether the market is favoring the bulls or the bears. Follow its lead, and you’ve got most of your work as a trader finished.
Let’s Go Next Level Today…
I mentioned that applying the same simple rule to the 50-day trend at the stock level will work to generate bullish and bearish candidates for trades. Well, let’s take a look at the current list of companies on my 50-day watchlist.
First, a small addition to the rule…
There are companies like Apple Inc (AAPL) and Alphabet Inc. (GOOGL) that are in the S&P 500 and trading with bullish 50-day trends. In some cases, I may want to trade these bullish trends, but it is generally on a healthy pullback, not at their highs.
To narrow my watchlist down, I look specifically for stocks that are trading closer to their respective bullish or bearish MA50s. This generates a list of stocks that are more likely to see significant rallies as they fortify their trends.
For what it’s worth, out of all the companies in the S&P 500, we’re looking at a literal 50/50 split between those trading above or below their MA50s. That said, here’s the current list of companies in the S&P within 1% of their bullish or bearish MA50:
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Source: Money Morning