First, what is technical analysis? Is it voodoo? A lost black art? No, it's a method of evaluating securities by analyzing statistics generated usually by past prices and volume. In the belief that past is prologue, technical investors look at historical price and volume patterns on charts that will indicate future performance. A company's intrinsic value doesn't matter, nor do generic categories of valuation such as value or growth equities.
The more common technical tools are moving averages and relative-strength indicators, or RSIs, often referred to as "momentum." One of the most widely used technical indicators is simple moving averages such as 50-day (10 weeks calculated using five trading days per week) and 200-day moving averages based on closing prices. These would be considered medium-term and long-term moving averages. Short-term would be in the range of 20 day or four weeks or less. The interesting perspective on moving averages is that they may just be self-fulfilling indicators. Since so many investors and traders use them, it's possible that once moving-average trends are triggered, enough traders and investors act on them to actually make the indicator relevant.
In my opinion, most investors use moving averages to obtain levels of price support and price resistance for indices and individual stocks. For example, support is a price level below the current market price at which buying interest should be able to overcome selling pressure and thus keep the price from going any lower. The reverse is true for resistance. A 200-day moving average might represent long-term price support for a stock. If a stock breaks appreciably below its 200-day moving average, that may be an indicator that there's more than just price weakness involved. In other words, to technical investors, the price change reflects all the information known about the stock, fundamental or otherwise, without any personal bias.
RSIs are a favorite of momentum investors. The RSI is a comparison between the number of days that a stock finishes up against the number of days it finishes down. The number of days can vary, but it will usually be less than or equal to three weeks of trading days. This indicator is a big tool in momentum investing and is usually represented by a ratio between 0 and 100. Generally, the market is considered short-term overbought when the ratio is at or above 70 to 80 and oversold between 20 and 30. To me, it's clearly a short-term indicator and used primarily by aggressive investors who are active traders.
If this sounds like mumbo-jumbo to you, I'm not surprised. However, to ignore the technicals when entering or exiting a tech investment can leave money on the table.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.
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