Technical Analysis Toolbox. 7 Checklist of Key Technical Tools. 3 Basic Goals of the Technical Analysis Tools

There are five major categories of tools in a complete technical analysis toolbox, and novice chartists need only to have a basic understanding of what they do.

The Three Basic Goals of the Tools

1.    Find obvious patterns and trends
2.    Check an indicator or two
3.    Compare current condition to others

1.    Seeing where the stock is currently trading and figuring out how it got there
This is where we explore charting tools such as:
    stock trends,
    support levels (that point at which a stock is trading at which demand is thought to be strong enough to prevent the price from declining further), and
    resistance levels (that price at which selling is thought to be strong enough to prevent the price from rising further).
We’ll also try to find a pattern or a trend to help.

2.    Determining the power of a trend
This is also where we can find signs of an imminent end of a trend. For that, we will look at important technical concepts such as trading volume and momentum.

3.    Making comparisons of the stock to the market, its peers in its own industry and even to its own history
This is where we look at relative performance and moving averages. We have not covered relative performance of a stock to its industry group yet, but it is simple enough to cover directly here.
If we know how fast a stock is moving, how much power is behind it and how it stacks up to the market, then we’ll gain a huge advantage over other investors looking only at the fundamentals (such as price-to-earnings ratios, return on equity, or earnings growth).

In looking at a stock, here is a checklist of key technical tools. Any potential investment should meet most, but not necessarily all, of these criteria.

Price Structure
Trends and Trendlines
There is no secret to finding a trend. If prices are generally rising and making higher highs as well as higher lows, then we have a rising trend. Most charting web sites also offer the ability to draw trendlines on the chart to clearly define the trend more objectively. Alternatively, the old-fashioned way of printing the chart and using a ruler and pencil works just as well.
 We want stocks that are in rising trends.

Support and Resistance
These are terms that simply tell us what price levels are likely to bring out the buyers (demand) or the sellers (supply), respectively.
 What we want to see is a current price that has either just moved through resistance (demand overwhelmed supply) or one that is far from the next resistance level.

Moving Averages
Moving averages (or simply price averages) are just average prices over a user-defined period of time, usually 50 or 200 days. They help us determine if a trend is turning, as prices cross the averages. They also help us determine if an existing trend is progressing in an orderly manner, or if it is accelerating in a frenzy.
 Clearly, we are looking for prices to be above selected averages but not too far above them.

Relative Performance
Relative performance charts simply divide the price of a stock by a relevant market index or industry group. The theory is that we should buy strong stocks in strong sectors and this is how we find them. If the ratio is going up, then the stock is outperforming the market or industry and is thus a strong candidate for further gains. If the ratio is going down, then the stock is lagging and is often more vulnerable to bad news.
 We are looking for stocks whose relative performance is increasing.

Volume
The number of shares traded and when those shares trade—either on days when prices rise or when they fall—can confirm the health of a trend or warn of an impending change.
 We are looking to see if buying is spreading to other investors and for urgency for all to buy when prices start to rise.
Fear of missing a good thing causes these surges.

Momentum
Jargon alert! The next paragraph is summarized in one sentence at the end.
We also want to know if days when the stock rises outnumber those when it falls. Are the gains on these positive days greater than the losses on negative days? When the losing days are bigger and more frequent than the winning days we can surmise that the trend is weakening.
 We want to know if momentum is strong but not too euphoric.

Sentiment
We’ll just worry about obvious extremes in sentiment, as this portion of the analysis is tricky even for the pros. Is everybody thinking the same thing? That’s the time to go the other way. And as some traders will say, sometimes the best trades are the ones that make you sick as you leave the comfort of the crowd.
Note     Sometimes the best trades are the ones that make you sick as you leave the comfort of the crowd.
 We want to know if everyone is thinking the same thing.

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