Basic Technical Analysis
Contributed by Brandon Larson, Business Development Specialist, DisnatDirect

Technical analysis is the inspection of historical price movements to forecast future price actions. Technical analysts are also commonly referred to as chartists because they rely almost exclusively on charts for their analysis. With hundreds of different technical analysis techniques available, the trick is finding the few techniques that work best for you.

Most people use either technical or fundamental analysis or a combination of the two when researching stock. Fundamental analysis is a technique where an investor will use mostly quantitative data on a security and apply that to predict future movements of a stock. Quantitative data is usually obtained from various company reports and could include current earnings, past earnings and proven probable reserves..

Technical analysts will look for trends and then predict price movements. Trends can be found in various types of charts including: candlestick, bar, moving averages and support and resistance among others. Because technical analysis involves locating trends and finding the buying/selling signals, many technical analysts will make a trading decision on a stock without knowing what that company does.

When charting a specific company, there are many different types of charts that can be used. However, the two most commonly used are the OHLC (open, high, low & close) chart and the candlestick chart.

OHLC charts provide analysts with the opening price, closing price, high price for the period and low price for the period. A major downfall of the OHLC chart is that it can be very difficult to determine whether the security closed higher or lower than the opening price for the time period being analyzed.

Candlestick charts clearly determine which direction the security moved for a particular period. On top of showing the same indicators as the OHLC chart, the candlestick chart will use either a hollow or filled-in body to indicate the price movement. If the area between the open and the close for the day (the body) is hollow (no colour) then the security closed higher or up. If the same area is filled in then the security closed lower or down. This can be of tremendous assistance to an analyst when determining the current price trend of a security.
               

The line (shadow) above and below the body of the candlestick indicates the high and the low for the chosen time period. If there is a shadow only above and not below, or below and not above the box, that is known as a hammer.

When charting a security using OHLC, candlestick or any other chart, many chartists will incorporate a moving average in the chart as well. Moving averages are usually derived from past closing prices of a security and are used to help determine future price movements. The moving average is an average closing price for a specific time frame. For instance, a 50-day moving average will be plotted on a chart as an average of the closing price of the security for the past 50 days. A very common technique is to use two moving averages, a 15-day and a 50-day for example. When the 15-day moving average crosses over the 50-day moving average on an uptrend, this usually indicates a positive price movement or a buy signal. If the 15-day moving average crosses over the 50-day moving average on a downtrend, this usually indicates a negative price movement or a sell signal.

Many chartists will also use Bollinger Bands in conjunction with the moving averages. There are usually three lines on a chart when using Bollinger Bands, an upper Bollinger Band, a lower Bollinger Band and a moving average between them. Theupper and lower bands are based on a standard deviation which is a function of volatility. The wider the gap between the upper and lower band, the higher the volatility; lower volatility is indicated by a smaller gap between the bands.

All of the various types of indicators, including the ones mentioned above can be broken down into two basic types: lagging (following) and leading. Lagging indicators are trend-following indicators (with longer time periods) that work with a high accuracy probability when the underlying securities develop strong trends. Lagging indicators are calculated so traders can enter and remain in a position as long as the trend continues. Following or lagging indicators are not efficient in trading ranges (where the market is moving up and down) and respond so slowly that the indicator will not indicate an early entry on a move or indicate a timely profitable exit.
    
Simple and exponential moving averages and Bollinger Bands are lagging indicators because they follow (or lag behind) the prices and only later in the move will the indicator offer a buy or sell signal. Lagging indicators have a high profit probability only in strongly trending markets.

Leading indicators provide an early high probability where the underlying securities might establish or break support and resistance. Leading indicators (usually with shorter time frames) are designed to lead prices rather than follow them. Most leading indicators represent a form of price momentum over a short fixed look-back period, which is the number of periods used to calculate the indicator. Momentum measures the rate-of-change of the underlying security, so as the price rises, price momentum increases. Leading indicators may give false early signals for entry and untrue exit signals, as the indicator may be too sensitive and react too quickly.

Disnat Direct is a Disnat product. Disnat is a division of Desjardins Securities. Desjardins Securities is a member of the Canadian Investor Protection Fund (CIPF).  For more information, go to www.disnatdirect.com