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Technical Analysis Part Two Indicators And Patterns

Aug 17, 2007
Charts and graphs are a great tool to help you decide what stock to invest in. Trained analysts, however, see patterns that are used to predict future movements of stock prices. There are hundreds of different indicators and patterns that can be applied. With that wealth of information at your disposal, you will be better able to make plans for your financial future.

1. Patterns

If you see a high then a dip, you can invest during the dip period and expect to ride the second side of the dip back up to make a profit. They finally level out for a period (handle) before making a breakout a sudden rise in price. Investors who buy on the handle can make good profits.

Another popular pattern is Head and Shoulders. This is formed by a peak (first shoulder) followed by a dip and then a higher peak (the head) followed again by a dip and a rise (the second shoulder). This is taken to be a bearish pattern with prices to fall substantially after the second shoulder.

2. Indicators

Moving Average

The most popular indicator is the moving average. This shows the average price over a period of time. For a 30 day moving average you add the closing prices for each of the 30 days and divide by 30. The most common averages are 20, 30, 50, 100, and 200 days. Longer time spans are less affected by daily price fluctuations. A moving average is plotted as a line on a graph of price changes. When prices fall below the moving average they have a tendency to keep on falling. Conversely, when prices rise above the moving average they tend to keep on rising.

3. Relative Strength Index (RSI)

This indicator compares the number of days a stock finishes up with the number of days it finishes down. It is calculated for a certain time span usually between 9 and 15 days. The average number of up days is divided by the average number of down days. This number is added to one and the result is used to divide 100. This number is subtracted from 100. The RSI has a range between 0 and 100. A RSI of 70 or above can indicate a stock that is overbought and due for a fall in price. When the RSI falls below 30 the stock may be oversold and is a good time to buy. These numbers are not absolute they can vary depending on whether the market is bullish or bearish. RSI charted over longer periods tend to show less extremes of movement. Looking at historical charts over a period of a year or so can give a good indicator of how a stock price moves in relation to its RSI.

4. Money Flow Index (MFI)

The RSI is calculated by following stock prices, but the Money Flow Index (MFI) takes into account the number of shares traded as well as the price. The range is from 0 to 100 and just like the RSI, an MFI of 70 is an indicator to sell and an MFI of 30 is an indicator to buy. Also like the RSI, when charted over longer periods of time the MFI can be more accurate as an indicator.

5. Bollinger Bands

As an absoulte best indicator, be sure to check out bollinger bands which is a graph plotted along three lines. The upper and lower lines are plotted according to market volatility. When the market is volatile the space between these lines widens and during times of less volatility the lines come closer together. The middle line is the simple moving average between the two outer lines (bands). As prices move closer to the lower band the stronger the indication is that the stock is oversold the price should soon rise. The more information you have, the better decisions you can make.
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