When it comes to investing, the term ‘technical analysis’ can cause many heads to spin. But the truth is that this is a frequently used tool for professional investors to help them decide which stocks to buy and when. This article explains technical indicators and how they can be used.
When it comes to investing, the term ‘technical analysis’ can cause many heads to spin.
But the truth is that professional investors frequently use this tool to help make decisions on which stocks to buy or sell, and when.
In fact, technical analysis was the most used decision-making tool by Australia-based traders, ranking above fundamental analysis and broker recommendations, according to a 2016 report by research house, Investment Trends.
So what exactly are technical indicators?
The process involves studying the movements and patterns in historical market data as an indicator of future prices and market direction. If one believes that markets are perfectly efficient or are a random walk, then technical analysis would not be of great use. But we believe markets are far from efficient.
There are many technical analysis concepts. Some of the most popular include head and shoulders, Elliott wave, Bollinger band, Ichimoku clouds, candlestick, hanging man, morning star, congestion zone, and false breakout. Sounds simple right?
A good fund manager will use a number concepts, overlaid with fundamental investment analysis. At AMP Capital, there are three main ways we look at markets using technical analysis:
1. The trend is your friend
Trend is determined by the slope of the market. Markets can be in an uptrend, a flat trend, or a downtrend, over different time horizons.
There is an expression in the markets that ‘the trend is your friend’ - and it can be until the trend changes. This is where experience helps, as identifying trend changes can be difficult, using momentum indicators and looking for breakouts below an uptrend or above a downtrend as confirmation can help better identify turning points.
2. Momentum play
Momentum focuses on determining the ‘health’ and longevity of the trend through indicators such as the Relative Strength Index (RSI) which measures the speed and change of price movements. This helps determine whether a market is overbought or oversold, which when in these extreme areas, can signal a higher probability of a reversal or trend change.
3. Market Strength
Market strength can be assessed in various ways including market breadth, volume, or relative performance. Breadth looks at whether moves higher or lower in the market have broad support or are concentrated in a small number of securities, whereby positive breadth indicates that more securities in the underlying market are advancing rather than declining. Similarly, for volume, it is a positive sign to see a strong rally in the market supported by increased volume traded. Relative performance uses ratios to look at how one market has performed relative to another market.
There are a number of different ways of analysing investment opportunities as an investor. Investment professionals believe that technical analysis can lead to more informed decision making and provides an important source of value add when it is used in conjunction with other investment analysis. Other useful indicators would include valuations, where in the cycle we are, liquidity, and sentiment.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.