• The Technicals

Technicals refers to factors related to a stock's price and volume action. What you see on stock charts are generally technical elements, a stock's price and volume of shares traded on any given day. Fundamentals are measures that describe a company and its performance, not its stock

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• Technical Analysis Basics

Bases seen on charts, breakouts, correct buy points, proper buy zones and rebounds from support at the 10-week moving average all fall into the technical category. So do sell signals, and discussions of whether a stock base is early or late stage.

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• What Is Technical Analysis?

Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.

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• Understanding Technical Analysis

Technical analysis focuses on the study of price and volume. Technical analysis tools are used to scrutinize the ways supply and demand for a security will affect changes in price, volume, and implied volatility. Technical analysis is often used to generate short-term trading signals from various charting tools, but can also help improve the evaluation of a security's strength or weakness relative to the broader market or one of its sectors. This information helps analysts improve their overall valuation estimate.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far more prevalent in commodities and forex markets where traders focus on short-term price movements.

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• Indicators

Technical analysis attempts to forecast the price movement of virtually any tradable instrument that is generally subject to forces of supply and demand, including stocks, bonds, futures, and currency pairs. In fact, some view technical analysis as simply the study of supply and demand forces as reflected in the market price movements of a security. Technical analysis most commonly applies to price changes, but some analysts track numbers other than just price, such as trading volume or open interest figures.

Across the industry, there are hundreds of patterns and signals that have been developed by researchers to support technical analysis trading. Technical analysts have also developed numerous types of trading systems to help them forecast and trade on price movements. Some indicators are focused primarily on identifying the current market trend, including support and resistance areas, while others are focused on determining the strength of a trend and the likelihood of its continuation. Commonly used technical indicators and charting patterns include trendlines, channels, moving averages, and momentum indicators.

In general, technical analysts look at the following broad types of indicators:

- Price trends

- Chart patterns

- Volume and momentum indicators

- Oscillators

- Moving averages

- Support and resistance levels

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• Limitations of Technical Analysis

Some analysts and academic researchers expect that the EMH demonstrates why they shouldn't expect any actionable information to be contained in historical price and volume data. However, by the same reasoning, neither should business fundamentals provide any actionable information. These points of view are known as the weak form and semi-strong form of the EMH.

Another criticism of technical analysis is that history does not repeat itself exactly, so price pattern study is of dubious importance and can be ignored. Prices seem to be better modeled by assuming a random walk.

A third criticism of technical analysis is that it works in some cases but only because it constitutes a self-fulfilling prophesy. For example, many technical traders will place a stop-loss order below the 200-day moving average of a certain company. If a large number of traders have done so and the stock reaches this price, there will be a large number of sell orders, which will push the stock down, confirming the movement traders anticipated.

Then, other traders will see the price decrease and also sell their positions, reinforcing the strength of the trend. This short-term selling pressure can be considered self-fulfilling, but it will have little bearing on where the asset's price will be weeks or months from now. In sum, if enough people use the same signals, they could cause the movement foretold by the signal, but over the long run this sole group of traders cannot drive price.

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• Level II Quotes

Level II can provide enormous insight into a stock's price action. It can tell you what type of traders are buying or selling a stock, where the stock is likely to head in the near term, and much more. Below, we'll explain what Level II is, how it works, and how it can help you better understand open interest in a given stock.

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• What Is Level II

Level II is essentially the order book for Nasdaq stocks. When orders are placed, they are placed through many different market makers and other market participants.

Level II will show you a ranked list of the best bid and ask prices from each of these participants, giving you detailed insight into the price action. Knowing exactly who has an interest in a stock can be extremely useful, especially if you are day trading.

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• Why Use Level II?

Level II quotes can tell you a lot about what is happening with a given stock:

You can tell what kind of buying is taking place—retail or institutional—by looking at the type of market participants involved. Large institutions do not use the same market makers as retail traders.

If you look at ECN order sizes for irregularities, you can tell when institutional players are trying to keep the buying quiet (which can mean a buyout or accumulation is taking place). We'll take a look at how you can detect similar irregularities below.

By trading with the ax when the price is trending, you can greatly increase your odds of a successful trade. Remember, the ax provides liquidity, but its traders are out there to make a profit just like anyone else.

By looking for trades that take place in between the bid and ask, you can tell when a strong trend is about to come to an end. This is because these trades are often placed by large traders who take a small loss in order to make sure that they get out of the stock in time.

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• What Is a Pattern?

Patterns are the distinctive formations created by the movements of security prices on a chart. A pattern is identified by a line that connects common price points, such as closing prices or highs or lows, during a specific period of time. Chartists seek to identify patterns as a way to anticipate the future direction of a security’s price. Patterns are the foundation of technical analysis.

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• How Patterns Work

Patterns in security prices, perhaps better known as trading patterns, can occur at any point or measure in time. While price patterns may be simple to detect in hindsight, spotting them in real time is a much larger challenge. There are numerous types of patterns in technical analysis, including the cup and handle, ascending/descending channels, and the head-and-shoulders pattern.

There are two primary types of stock analysis: fundamental and technical. Fundamental analysis looks at the specifics of a company’s business, conducting research on earnings projections, balance sheets, price-to-book ratios and much more. Technical analysis is mostly involved with pattern recognition, regardless of performance. These patterns are then used to uncover pricing trends. Fundamental analysis can help determine what to buy, while technical analysis can help determine when to buy. Well-rounded investors will apply both studies.

Technical analysts use chart patterns to find trends in the movement of a company’s stock price. Patterns can be based on seconds, minutes, hours, days, months or even ticks and can be applied to bar, candlestick, and line charts. The most basic form of chart pattern is a trend line.

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• Trend Lines

"The trend is your friend" is a common catchphrase among technical analysts. A trend can often be found by establishing a line chart. A trend line is the line formed between a high and a low. If that line is going up, the trend is up. If the trend line is sloping downward, the trend is down. Trend lines are the foundation for most chart patterns.

They are also useful for finding support and resistance levels, which can also be discovered through pattern recognition. A line of support is a historical level that a stock price hasn't traded below; a line of resistance is a historical point where a stock hasn't traded above.

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• Pattern Types

There are two basic types of patterns: continuation and reversal. Continuation patterns identify opportunities for traders to continue with the trend. There are also retracements or temporary consolidation patterns where a stock will not continue with the trend. The most common continuation patterns include ascending and descending triangles, flag patterns, pennant patterns, and symmetrical triangles.

The opposite of a continuation pattern is a reversal pattern. These are employed to find favorable opportunities to base a trade on the reversal of a trend. In other words, reversal patterns seek to unearth where trends have ended. "The trend is your friend until it bends" is another catchphrase for those looking for a reversal in a trend. Common reversal patterns are double tops and bottoms, head-and-shoulders patterns, and triple tops and bottoms.

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• Technical Indicator

In technical analysis in finance, a technical indicator is a mathematical calculation based on historic price, volume, or (in the case of futures contracts) open interest information that aims to forecast financial market direction.[1] Technical indicators are a fundamental part of technical analysis and are typically plotted as a chart pattern to try to predict the market trend.[2] Indicators generally overlay on price chart data to indicate where the price is going, or whether the price is in an "overbought" condition or an "oversold" condition.

Many technical indicators have been developed and new variants continue to be developed by traders with the aim of getting better results. New Indicators are often backtested on historic price and volume data to see how effective they would have been to predict future events.

In technical investigation, a bogus sign alludes to a sign of future value developments that gives an off base image of the financial reality. False signs may emerge because of various components, including timing slacks, inconsistencies in information sources, smoothing strategies or even the calculation by which the pointer is determined. Technical analysis tries to capture market psychology and sentiment by analyzing price trends and chart patterns for possible trading opportunities. Traders should be careful when taking trades solely based on indicators since they are not foolproof.

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• What Is a Technical Indicator?

Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest of a security or contract used by traders who follow technical analysis.

By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include the Relative Strength Index (RSI), Money Flow Index (MFI), stochastics, moving average convergence divergence (MACD), and Bollinger Bands®.

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• How Technical Indicators Work

Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security’s intrinsic value based on financial or economic data, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security’s strength or weakness.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far more prevalent in commodities and forex markets, where traders focus on short-term price movements.

Technical indicators, also known as “technicals,” are focused on historical trading data, such as price, volume, and open interest, rather than the fundamentals of a business, such as earnings, revenue, or profit margins. Technical indicators are commonly used by active traders, since they’re designed to analyze short-term price movements, but long-term investors may also use technical indicators to identify entry and exit points.

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• Types of Indicators

Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart. Examples include moving averages and Bollinger Bands.

Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD, or RSI.

Traders often use many different technical indicators when analyzing a security. With thousands of different options, traders must choose the indicators that work best for them and familiarize themselves with how they work. Traders may also combine technical indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up with trade ideas. Technical indicators can also be incorporated into automated trading systems, given their quantitative nature.

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• Momentum

Momentum is the speed or velocity of price changes in a stock, security, or tradable instrument. Momentum shows the rate of change in price movement over a period of time to help investors determine the strength of a trend. Stocks that tend to move with the strength of momentum are called momentum stocks.

Momentum is used by investors to trade stocks in an uptrend by going long (or buying shares) and going short (or selling shares) in a downtrend. In other words, a stock can be exhibit bullish momentum, meaning the price is rising, or bearish momentum where the price is steadily falling.

Since momentum can be quite powerful and indicate a strong trend, investors need to recognize when they're investing with or against the momentum of a stock or the overall market.

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• Understanding Momentum

Momentum measures the rate of the rise or fall in stock prices. For trending analysis, momentum is a useful indicator of strength or weakness in the issue's price. History has shown that momentum is far more useful during rising markets than falling markets because markets rise more often than they fall. In other words, bull markets tend to last longer than bear markets.

Momentum is analogous to a train whereby the train slowly accelerates when it starts moving, but during the ride, the train stops accelerating. However, the train moves but at a higher velocity because all of the momentum built up from accelerating is propelling it forward. At the end of the ride, the train decelerates as it slows down.

In the markets, some investors might get in and buy a stock early while the price is beginning to accelerate higher, but once the fundamentals kick in and it's clear to market participants that the stock has upward potential, the price takes off. For momentum investors, the most profitable part of the ride is when prices are moving at a high velocity.

Of course, once the revenue and earnings are realized, the market usually adjusts its expectations and the price retraces or comes back down to reflect the financial performance of the company.

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• Calculating Momentum

There are many charting software programs and investing websites that can measure momentum for a stock so that investors don't have to calculate it anymore. However, it's important to understand what goes into those calculations to better understand what variables are used in determining a stock's momentum or trend.

Market momentum is measured by continually taking price differences for a fixed time interval. To construct a 10-day momentum line, simply subtract the closing price 10 days ago from the last closing price. This positive or negative value is then plotted around a zero line. - Various formulas can be found online.

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• What Is a Trend?

A trend is the overall direction of a market or an asset's price. In technical analysis, trends are identified by trendlines or price action that highlight when the price is making higher swing highs and higher swing lows for an uptrend, or lower swing lows and lower swing highs for a downtrend.

Many traders opt to trade in the same direction as a trend, while contrarians seek to identify reversals or trade against the trend. Uptrends and downtrends occur in all markets, such as stocks, bonds, and futures. Trends also occur in data, such as when monthly economic data rises or falls from month to month.

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• How Trends Work

Traders can identify a trend using various forms of technical analysis, including trendlines, price action, and technical indicators. For example, trendlines might show the direction of a trend while the relative strength index (RSI) is designed to show the strength of a trend at any given point in time.

An uptrend is marked by an overall increase in price. Nothing moves straight up for long, so there will always be oscillations, but the overall direction needs to be higher in order for it to be considered an uptrend. Recent swing lows should be above prior swing lows, and the same goes for swing highs. Once this structure starts to break down, the uptrend could be losing steam or reversing into a downtrend. Downtrends are composed of lower swing lows and lower swing highs.

While the trend is up, traders may assume it will continue until there is evidence that points to the contrary. Such evidence could include lower swing lows or highs, the price breaking below a trendline, or technical indicators turning bearish. While the trend is up, traders focus on buying, attempting to profit from a continued price rise.

When the trend turns down, traders focus more on selling or shorting, attempting to minimize losses or profit from the price decline. Most (not all) downtrends do reverse at some point, so as the price continues to decline, more traders begin to see the price as a bargain and step in to buy. This could lead to the emergence of an uptrend again.

The lack of a trend—that is, a period of time where there is little overall upward or downward progress—is called a range or trendless period.

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• Using Trendlines

A common way to identify trends is using trendlines, which connect a series of highs (downtrend) or lows (uptrend). Uptrends connect a series of higher lows, creating a support level for future price movements. Downtrends connect a series of lower highs, creating a resistance level for future price movements. In addition to support and resistance, these trendlines show the overall direction of the trend.

While trendlines do a good job of showing overall direction, they will often need to be redrawn. For example, during an uptrend, the price may fall below the trendline, yet this doesn't necessarily mean the trend is over. The price may move below the trendline and then continue rising. In such an event, the trendline may need to be redrawn to reflect the new price action.

Trendlines should not be relied on exclusively to determine the trend. Most professionals also tend to look at price action and other technical indicators to help determine if a trend is ending or not. In the example above, a drop below the trendline isn't necessarily a sell signal, but if the price also drops below a prior swing low and/or technical indicators are turning bearish, then it might be.

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• What is stock market volatility?

Stock market volatility is a measure of how much the stock market's overall value fluctuates up and down. Beyond the market as a whole, individual stocks can be considered volatile as well. More specifically, you can calculate volatility by looking at how much an asset's price varies from its average price. Standard deviation is the statistical measure commonly used to represent volatility.

Some stocks are more volatile than others. Shares of a large blue-chip company may not make very big price swings, while shares of a high-flying tech stock may do so often. That blue-chip stock is considered to have low volatility, while the tech stock has high volatility. Medium volatility is somewhere in between. An individual stock can also become more volatile around key events like quarterly earnings reports.

Volatility is often associated with fear, which tends to rise during bear markets, stock market crashes, and other big downward moves. However, volatility doesn't measure direction. It's simply a measure of how big the price swings are. You can think of volatility as a measure of short-term uncertainty.

Historical volatility is a measure of how volatile an asset was in the past, while implied volatility is a metric that represents how volatile investors expect an asset to be in the future. Implied volatility can be calculated from the prices of put and call options.

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• What Is Volatility?

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured as either the standard deviation or variance between returns from that same security or market index.

In the securities markets, volatility is often associated with big swings in either direction. For example, when the stock market rises and falls more than one percent over a sustained period of time, it is called a "volatile" market. An asset's volatility is a key factor when pricing options contracts.

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• Understanding Volatility

Volatility often refers to the amount of uncertainty or risk related to the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, and tends to be more steady.

One way to measure an asset's variation is to quantify the daily returns (percent move on a daily basis) of the asset. Historical volatility is based on historical prices and represents the degree of variability in the returns of an asset. This number is without a unit and is expressed as a percentage.

While variance captures the dispersion of returns around the mean of an asset in general, volatility is a measure of that variance bounded by a specific period of time. Thus, we can report daily volatility, weekly, monthly, or annualized volatility. It is, therefore, useful to think of volatility as the annualized standard deviation.

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• How to Calculate Volatility

Volatility is often calculated using variance and standard deviation. The standard deviation is the square root of the variance.

For simplicity, let's assume we have monthly stock closing prices of $1 through $10. For example, month one is $1, month two is $2, and so on. To calculate variance, follow the five steps below.

Find the mean of the data set. This means adding each value and then dividing it by the number of values. If we add, $1, plus $2, plus $3, all the way to up to $10, we get $55. This is divided by 10 because we have 10 numbers in our data set. This provides a mean, or average price, of $5.50.

Calculate the difference between each data value and the mean. This is often called deviation. For example, we take $10 - $5.50 = $4.50, then $9 - $5.50 = $3.50. This continues all the way down to the first data value of $1. Negative numbers are allowed. Since we need each value, these calculations are frequently done in a spreadsheet.

Square the deviations. This will eliminate negative values.

Add the squared deviations together. In our example, this equals 82.5.

Divide the sum of the squared deviations (82.5) by the number of data values.

In this case, the resulting variance is $8.25. The square root is taken to get the standard deviation. This equals $2.87. This is a measure of risk and shows how values are spread out around the average price. It gives traders an idea of how far the price may deviate from the average.

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• Implied Volatility vs. Historical Volatility

Implied volatility (IV), also known as projected volatility, is one of the most important metrics for options traders. As the name suggests, it allows them to make a determination of just how volatile the market will be going forward. This concept also gives traders a way to calculate probability. One important point to note is that it shouldn't be considered science, so it doesn't provide a forecast of how the market will move in the future.

Unlike historical volatility, implied volatility comes from the price of an option itself and represents volatility expectations for the future. Because it is implied, traders cannot use past performance as an indicator of future performance. Instead, they have to estimate the potential of the option in the market.

Also referred to as statistical volatility, historical volatility (HV) gauges the fluctuations of underlying securities by measuring price changes over predetermined periods of time. It is the less prevalent metric compared to implied volatility because it isn't forward-looking.

When there is a rise in historical volatility, a security's price will also move more than normal. At this time, there is an expectation that something will or has changed. If the historical volatility is dropping, on the other hand, it means any uncertainty has been eliminated, so things return to the way they were.

This calculation may be based on intraday changes, but often measures movements based on the change from one closing price to the next. Depending on the intended duration of the options trade, historical volatility can be measured in increments ranging anywhere from 10 to 180 trading days.

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• What Is Volume Analysis?

Volume analysis is the examination of the number of shares or contracts of a security that have been traded in a given time period. Volume analysis is used by technical analysts as one of many factors that inform their trading decisions. By analyzing trends in volume in conjunction with price movements, investors can determine the significance of changes in a security's price.

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• Understanding Volume Analysis

Volume analysis is done by all types of analysts following specific securities in the financial markets. Generally, volume refers to the number of shares transacted per day. Having an understanding of the entire market’s trading volume versus the volume of a single holding can be one important comparison that helps analysts to discern volume trends.

Oftentimes, high volumes of trading can infer a lot about investors’ outlook on a market or security. A significant price increase along with a significant volume increase, for example, could be a credible sign of a continued bullish trend or a bullish reversal. Adversely, a significant price decrease with a significant volume increase can point to a continued bearish trend or a bearish trend reversal.

In general, it can be important for technical analysts to include volume charts in daily charting diagrams. Volume charts are usually available below a standard candlestick graph. These charts will also usually display moving average trendlines. Incorporating volume into a trading decision can help an investor to have a more balanced view of all the broad market factors that could be influencing a security’s price which helps an investor to make a more informed decision.

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• Key Takeaways

Volume analysis involves examining relative or absolute changes in an asset's trading volume in order to make inferences about future price movements. Volume can be an indicator of market strength, as rising markets on increasing volume are typically viewed as strong and healthy. When prices fall on increasing volume, the trend is gathering strength to the downside. Various tools, such as the positive volume index (PVI) are employ volume in technical analysis.

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• Using Volume

Trading volume is a measure of how much of a given financial asset has traded in a period of time. For stocks, volume is measured in the number of shares traded and, for futures and options, it is based on how many contracts have changed hands. The numbers, and other indicators that use volume data, are often provided with online charts.

Looking at volume patterns over time can help get a sense of the strength or conviction behind advances and declines in specific stocks and entire markets. The same is true for options traders, as trading volume is an indicator of an option's current interest. In fact, volume plays an important role in technical analysis and features prominently among some key technical indicators.

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• Basic Guidelines

When analyzing volume, there are usually guidelines used to determine the strength or weakness of a move. As traders, we are more inclined to join strong moves and take no part in moves that show weakness—or we may even watch for an entry in the opposite direction of a weak move. These guidelines do not hold true in all situations, but they offer general guidance for trading decisions.

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• 1. Trend Confirmation

A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm in order to keep pushing prices higher. Increasing price and decreasing volume might suggest a lack of interest, and this is a warning of a potential reversal. This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed.

2. Exhaustion Moves and Volume

In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signals the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers.

At a market bottom, falling prices eventually force out large numbers of traders, resulting in volatility and increased volume. We will see a decrease in volume after the spike in these situations, but how volume continues to play out over the next days, weeks, and months can be analyzed using the other volume guidelines.

3. Bullish Signs

Volume can be useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If the price on the move back lower doesn't fall below the previous low, and volume is diminished on the second decline, then this is usually interpreted as a bullish sign.

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4. Volume and Price Reversals

After a long price move higher or lower, if the price begins to range with little price movement and heavy volume, this might indicate that a reversal is underway, and prices will change direction.

5. Volume and Breakouts vs. False Breakouts

On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in the move. Little change in volume or declining volume on a breakout indicates a lack of interest and a higher probability for a false breakout.

6. Volume History

Volume should be looked at relative to recent history. Comparing today to volume 50 years ago might provide irrelevant data. The more recent the data sets, the more relevant they are likely to be.

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• Volume Indicators

Volume indicators are mathematical formulas that are visually represented in most commonly used charting platforms. Each indicator uses a slightly different formula, and traders should find the indicator that works best for their particular market approach.

Indicators are not required, but they can aid in the trading decision process. There are many volume indicators to choose from, and the following provides a sampling of how several of them can be used.

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