Investing Basics: Technical Analysis

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Narrator: The term "technical analysis" might sound a little, well, technical, but it's actually pretty simple.

On-screen text: Disclosure: Past performance is not a guarantee of future results.

Narrator: Essentially, it's a strategy an investor may use to examine an investment's chart in an attempt to forecast its future performance.

On-screen text: Disclosure: Stock trading involves high risks, and you can experience a significant loss of funds invested.

Narrator: Some investors may use technical analysis to attempt to identify when to enter or exit a stock position.

On-screen text: Disclosure: Schwab does not recommend the use of technical analysis as a sole means of investment research.

Narrator: When performing technical analysis, investors can use a variety of techniques and tools to analyze a chart. In this video, we'll focus on a few technical analysis basics, including trend, support and resistance, price patterns, and technical indicators.

Let's start with the first technique—trend. Trend is the general direction a stock's price is moving.

There are three kinds of trends: up, which is a series of higher highs and higher lows; down, which is a series of lower highs and lower lows; and sideways, which has roughly equal highs and lows.

Some investors determine a stock's trend by identifying the direction of its highs and lows. Trend may be important because many investors believe that a stock will generally continue in the same direction it's been going.

On-screen text: Disclosure: Past performance is not indicative of future results.

Narrator: These investors would anticipate a stock with a strong uptrend to continue to rise, while one with a strong downtrend will continue to fall.

Some investors draw lines to attempt to identify the trend. Investors can also draw lines to connect highs and lows. These lines are known as support and resistance levels, the next technique we'll discuss.

Support and resistance are price levels that the stock has had trouble breaking through. If a stock breaks through support or resistance, it could be a signal to enter or exit. For example, suppose a stock breaks through resistance, which is a level it repeatedly pulled back from in the past.

On-screen text: Disclosure: Stock trading involves high risks, and you can experience a significant loss of funds invested.

Narrator: Because it broke through resistance, an investor may believe that there's a good chance that the stock will continue to rise. So, broken resistance may be a good time to enter. On the other hand, if a stock fell past a support area, it may continue to fall. This could be considered a good time to exit.

After connecting support and resistance levels, a stock's price movement may resemble a certain shape. These shapes are called price patterns and are another technical analysis technique. Price patterns can build on support and resistance, allowing investors to attempt to predict more specific movements and try to point out even more precise entry and exit signals.

There are many different price patterns. Some examples include simple shapes, like triangles or flags, and more complex patterns, like head-and-shoulders or triple-tops.

Let's look at an example. This is called an ascending triangle, and it forms when a stock's highs are hitting resistance while its lows are steadily rising. Some investors might interpret the narrowing between the highs and lows as a signal that the stock's about to break through resistance. If it does, the stock's price is expected to rise in value after the breakout.

But not all investors exclusively use support and resistance and price patterns. Drawing lines and finding shapes can be subjective. Because of this, some investors may use technical indicators. Technical indicators are graphical representations of chart data. Each indicator displays chart data, like price and volume, in a unique way, giving investors another perspective of the stock's performance. Because technical indicators are created using formulas and data, they may give investors a more objective way to examine a stock's performance.

A common technical indicator is a moving average line. This indicator averages the stock's price over a period of time and plots it as a line, which can help determine the overall trend. Moving averages can be calculated for any period of time, but one of the most common is 50 days.

So, what does a moving average tell you about an investment? Imagine a stock's price crosses above its 50-day moving average. This may indicate that the stock is outperforming its recent history. This could be an entry signal. Similarly, if the stock begins to fall and dips below its moving average, it could be an exit signal.

Moving average lines are only one of many technical indicators investors may use. Other common indicators include price envelopes, Bollinger Bands^®, stochastic oscillators, and the relative strength index.

At this point, we've covered some basics of technical analysis. One thing to keep in mind is that technical analysis can help you identify potential entry and exit signals, but it offers no guarantee of success. After all, there's no way to predict the future.

We've only covered the tip of the technical analysis iceberg. Learning how to use the techniques and tools we've discussed, as well as the many others out there, can advance your technical analysis skills.

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