In my last technical analysis post moving averages and technical analysis, I ended by promising to show you how investors use technical analysis to make money in the stock market. That is a tall order!
First, let me tell you that there are many technical analysis strategies and indicators that traders use to make money in the stock market. In this post I will go through the basics of two distinct technical analysis strategies that are used to make money in the stock market.
1.) Many technical analysis strategies are based on momentum. That’s right, forget buy low and sell high; buy what’s going up and sell it when it goes up more. This is what technical analysts refer to as buy high and sell higher.
One popular momentum based investing style, CANSLIM, was developed by Investors Business Daily founder William O’Neill. This strategy identifies companies with accelerating earnings and revenues, along with a strong market and increasing investor sentiment (more money managers and mutual funds buying the stock).
Let’s face it, Economics 101 says that price is based on supply and demand. That said, and the average investor cannot move the price of a stock. Only the “Big money” such as mutual funds and pension funds can produce enough volume to significantly move the price of most stocks. You can learn more about CANLSIM at Investors Business Daily and see it used in real life over at Chris Perruna.com.
2) Other strategies look for reversal patterns in the charts. Some technical analysts will watch for increasing volume and stabilizing or rising stock prices to signal the reversal of a downtrend.
In markets that are downward trending, technical analysts will use price and volume, along with other indicators, in an attempt to find the bottom of a downward price trend.
Traders watching for these reversal situations will also monitor the previous support and resistance areas. If the stock has had previous support at a certain level, technical analysts will watch for that support to continue as the price drops to that level again. It is considered a Red flag when the price of a stock drops below its previous support level.
I know that I have been very vague and brief in my descriptions of these strategies. However, I always found it easier to understand when the information was explained without the jargon.
I sincerely hope that this has helped you to understand a little more about some technical analysis indicators. While I don’t use these to trade stocks, I do use some of these strategies to look for entry points to buy stocks that are already on my watch list for long-term buy and hold investment.