How to Trade Stocks - Basic Technical Analysis

Fundamental analysis helps you select stock to buy. Technical analysis (TA) helps you determine when to buy it. There are several good schools of ТА but the basics apply to all of them. You won't become a pro overnight - TA requires considerable study and practice - but knowing just the basics can materially improve your returns and/or save you from financial disaster.

Moving Averages

A 50 DMA (Day Moving Average) is the average price of a stock for the past 50 days plotted on a chart. A 200 DMA is the average price of a stock for the past 200 days plotted on a chart. A rising stock will have rising 50 and 200 DMAs, with the 50 DMA above the 200 DMA. Conversely, a declining stock will have declining 50 and 200 DMAs, with the 50 DMA below the 200 DMA.

Rising stocks generally stay above the rising 50 DMA, or close to it. Conversely, declining stocks stay below the declining 50 DMA.

Bottom fishing (buying stocks that are down a lot) on the premise that the market is wrong and you know better is the amateur's strategy that on balance produces disastrous results. It makes more sense to go with the trend by buying rising stocks while avoiding (or shorting) the declining ones.

Golden Cross

When a declining stock reverses and starts back up, the rising 50 DMA crosses above the 200 DMA - generally, a bullish sign.

Trendlines

Stocks don't move in a straight line, nor are their moves sporadic. They are either in an uptrend (going up) or in a downtrend (going down). A trendline is established by drawing a line through three separate highs or lows on a chart. The upper band is called resistance; the lower band is called support.

A stock trading between support and resistance is in the trading range.

Some stocks have long neat trendlines. Those that have multiple short trendlines going in all directions are said to have a broken chart.

Other Useful Technical Terms

Every once in a while a stock breaks out of the trading range by moving higher (breakout) or lower (breakdown). A breakout indicates the beginning of a new trend of importance. Some breakouts still fail. A stock that makes a powerful move and completely retracts it is said to have a reversal. A resumption of advance after the initial breakout is called a follow through.

After breakout, a stock can run for a few days before pulling back. A pullback is healthy as long as the stock does not undercut the previous low. Although each successive move higher increases the downside risk and reduces the upside potential, some traders chase the stock - i.e. buy it in a rapid runup.

Recognizable chart patterns that indicate that a stock is about to make a move of significance are called setups.

A stock making new highs is a bullish sign. Sometimes a stock may pull back before the close, printing an NCH (New Closing High).

Thinly traded stocks (stocks trading less than several hundred thousand shares a day) often experience a shakeout - a sudden intraday drop in price that fully recovers by the end of the day. The move shakes out weak hands - traders who don't have the stomach for wild fluctuations and sell in a panic. Some of these moves are orchestrated specifically for the purpose of shaking out the weak hands in order to buy their shares cheaply; others are the result of traders' herd mentality - following each other's closely watched moves. A person who sells in a shakeout and then buys back higher is said to be whipsawed.

A stock staging an unsustainable rise at the end of a run that looks almost vertical is said to go into a parabolic rise. A stock that has a big one-day fall that violates a major trendline is said to be broken.