| Simple (and complex) investment strategies |
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"Basically you're trying to determine the underlying market psychology based on historical price patterns," says Chip Anderson, founder and president of Stockcharts.com.
"If prices have been going up, you can use various techniques to decide if you think the prices are going to continue to go up, or reverse and go down. The ultimate goal is to find stocks that have a particular price pattern that you feel reflects a market psychology that you can use to predict future movements," Anderson says.
Technical analysis consists of three basic components: trends, levels of support and levels of resistance.
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| Technical analysis jargon demystified |
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Support and resistance are each points where stock prices repeatedly reverse course.
"You're not giving the numbers on the chart any magical power. What you're trying to think about is: Are the people that make up the market going to give any credence to a particular number -- for instance Dow (at) 10,000 or any stock hitting $100?" says Anderson.
"Those are numbers that often will cause people to pause, maybe just for half a second, or they may generate news articles around the world," he says.
Trends are movements across a chart that reflect prices going up, going down and staying flat.
"Trend is very similar to support and resistance, except it is an angled version of a support or resistance line," says Anderson.
If investors believe a stock will continue going up at a particular rate, there is a moving line that the price will not cross on the upside and the downside -- and the same for the reverse, if the trend is moving down.
The patterns formed on the charts can give investors information about what may happen in the future. A pattern is a recognizable picture formed by the price points plotted on the chart that may indicate future price movements.
For instance, some basic pattern formations are the head and shoulders pattern, and flags and pennants.
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