going up or down? April 30, 2011 PSW Staff |
fundamentals and decide which stock or stocks we would like to get involved with, technical analysis should not be overlooked. Looking at charts can be a good tool to decide when to enter a trade, what sort of profit target you should have, where you should keep a stop-loss or trailing stop-loss in place, and what sort of time horizon makes sense. This will help you determine whether or not the stock that you have chosen through fundamental analysis is a good fit for your own situation. Unfortunately, technical analysis cannot tell you what direction the stock will go in the future, no matter how much past evidence you have to work with. Think of it as being exactly like forecasting the weather. One or two days out, weather predictions can be fairly accurate, although not always. Look out five to ten days, however, and weather predictions are almost always inaccurate. This is because more often than not, trends continue from day to day. Add more and more variables, however, and more often than not, things change. So why do weather forecasters and technical stock analysts still have jobs? The reason is that there is a ton of value in preparing for major changes whether or not they actually occur. Lives can be saved and portfolios can also be saved when folks are warned that catastrophic events are likely to occur. The main problem with using technical analysis only is that you are making an assumption that all information, whether it be public or private, can be found within the charts. This includes information held by company insiders, market regulators, suppliers, competitors and even employees and contractors or consultants, as well as all publicly available reports and statistics. This predicates that markets are always 100% efficient, and assumes that greed and fear can be quantified. It can be proved that the current price of a stock is not 100% efficient. Just take a look at companies filing for bankruptcy. Had the price been efficient prior to, then the stock would not have fallen by 80% overnight. And if you think that insiders had no idea of the impending doom, perhaps you would be interested in some ocean front property in Arizona? You can also bet that the “gap” created overnight will never be filled. Despite all of this, charts are still great tools. We use candle stick charts, not because they show neat little patterns that have cool names, but because they contain more information than a standard line chart. Charts include everything you need to know about the past activity of a stock. How close is it to a one or two-year high? What has been the biggest one day move, or the smallest? Has trading activity been rising or falling? These simple visual observations can make a huge difference with respect to having realistic expectations. Stocks that are moving up are a tiny bit more likely to continue moving up, and stocks that are moving down are a tiny bit more likely to continue moving down. This is where fundamental analysis is key. As the stock has been moving up, has it become overpriced? What has happened to the P/E? If the stock has been moving down, has it become cheaper? Has the price fallen while earnings have not? Lets take a look at a popular technical analysis phenomenon known as bullish and bearish engulfing candlesticks. This occurs when a stock moves in one day, or whatever the period of the chart, by an amount that exceeds the movement of several of the previous days or periods movements. If that larger candle is green (finished the day higher than where it started), it is considered bullish, and if the candle is red (finished the day lower than where it started), it is considered bearish. Do we really need fancy names to tell us that a stock seeing a large one day gain is a bullish phenomenon, or that a stock seeing a large one day decline is a bearish one. Again, value does exist in technical analysis. When a stock has a large one day gain, yes, it is likely to continue higher, but what is this a function of. Look at the news, read the reports, if the only reason for the advance was technical, maybe there is some insider info that can be gained. Just be sure you realize that insiders, just like most humans, will always look out for themselves first. Unlike most penny stock websites, PSW provides completely UNBIASED analysis. In other words, we do not accept compensation in any form from companies or third parties to promote their stocks. This means that you get analysis and opinion on Small and Micro Cap stocks that is untainted and completely transparent. This is in stark contrast to 99% of all “Free” penny stock reports and “services”. 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