Support your investment decisions with a technical analysis education to make more profitable stock selections—but remember, it’s just one of many tools

Technical analysis is the process of analyzing a stock’s past and historical price movements to attempt to determine future prices.

Here’s how to use it to your advantage as an investor:

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Use a technical analysis education to support your findings on a stock

Use technical analysis for stocks to support—not determine—your view of a company. A far better approach is to look at a chart reading as one tool among many. But don’t look at the chart for a prediction of what’s going to happen. Look to see if the pattern on the chart seems to support your view of the stock, based on its finances and other fundamentals. But remember that the stock market follows a multitude of factors to varying extents, and the most important or influential factors continually change.

It’s encouraging if your analysis and the chart seem to match. But sometimes they don’t. If a company looks promising, but its chart shows a lengthy falling trend, insiders may know something you don’t. That’s when you know you have to dig deeper, and perhaps wait until the situation clarifies itself.

Look at the overall picture of technical analysis education to improve your stock selections

You need to look at the overall picture, rather than confine your view to your favourite selection of easily accessible statistical information. That’s the trouble with zeroing in on any single facet of investing. With a narrow view, you can get lucky and make a handful of brilliant trades. But to profit consistently in a long investing career, much less make any serious money, you have to take a broad view of the market and economy, you have to learn how to identify stocks that will go up and stay up, and you have to learn to diversify.

Many investors are well past age 35 when they make that essential discovery. The key to profiting from technical analysis for stocks is to avoid looking to the pattern on the chart for a prediction of what’s going to happen. Instead, see if the chart seems to support your view of the stock, based on its finances and other fundamentals.

Here’s a close look at one popular technical analysis tool

One well-known form of technical analysis is the Relative Strength Indicator (RSI). It charts a stock’s current and historical strength, or weakness, based on closing prices over a recent trading period. Specifically, it looks at whether a stock’s price on each of those trading days in the period closed up or down compared to the previous day’s closing price

The RSI then compares the overall magnitude of a stock’s recent gains to the magnitude of its recent losses and turns that data into a number that ranges from 0 to 100.

J. Welles Wilder developed the indicator and introduced it in his 1978 book New Concepts in Technical Trading Systems.

The RSI is most typically used on a 14-day timeframe, as first introduced by Wilder. Since then, the 9-day and 25-day Relative Strength Index indicators have also gained popularity.

The centerline for RSI is 50. Readings above and below are meant to suggest a bullish or bearish outlook, respectively. On the whole, a reading above 50 indicates that average gains are higher than average losses and a reading below 50 indicates that losses are winning out. RSI enthusiasts look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.

Wilder recommended using 70 as an overbought level (buyers are too optimistic and the stock could fall) and 30 as oversold (sellers are too pessimistic and the stock is ready to bounce upward).

Summing up: Technical analysis education is a positive for investors—but use caution

As I’ve often mentioned, I got my first investment-related job at age 16. Part of my work was drawing up charts, both line charts and point-and-figures. In my mid-20s, I worked for a couple of years as the technical analyst at a Toronto brokerage firm, though I did fundamental research there as well.

Technical analysis can be a useful tool, if you recognize it as one of many tools. Before making any recommendations or transactions in client accounts, I always look at a chart. However, I don’t look at the chart for a prediction on what’s going to happen. I look to see if the pattern on the chart seems to support the view that I’ve formed of the stock, based on its finances and other fundamental factors.

I find it encouraging if the two seem congruent, and they often do. But sometimes one contradicts the other. That’s when I know I have to dig deeper.

One thing I’ve observed over the years is that charts and technical analysis always seem to provide a misleading answer just when it can do the most damage to those who rely on them. That’s why I think it’s a big mistake to base investment decisions exclusively on charts or technical analysis of any kind.

Use technical analysis education in tandem with our three-part Successful Investor approach to profit in the stock market

1. Invest mainly in well-established, dividend-paying stocks;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities);
3. Downplay stocks in the broker/media limelight.

Some who use technical analysis believe that market action can show shifts in relationships between supply and demand. Why do you agree or disagree with this notion?

How do you analyze a stock to determine whether or not it’s a good fit for your portfolio?