Technicals Are Trending
Talk about increasing volatility isn’t the only thing on the rise. Technical market indicators have been thrown into casual conversation at a higher frequency, too, and they’re likely to remain hot topics as we watch markets whipsaw.
This week’s column seems, then, like a good time to demystify and define what a few of these terms mean, and lay out why traders and investors look to them as signals. The overarching theme of these indicators is, “don’t fight the trend,” which seems simple enough. The challenge, of course, is knowing how to identify the trend and when it might shift.
One of the most commonly mentioned indicators is the moving average of a security’s price level over a specified period such as 50 days, 100 days, or 200 days. The purpose of moving averages is to show the path (or trend) of prices by dampening the day-to-day oscillations that occur. In other words, a smoothed trend line of which direction the price is moving.
The noteworthy signals are:
• Where a security (or index) currently sits in relation to its moving averages
• When a security’s current price crosses over one of these lines, either above or below
• When one of these moving averages (usually the 50-day) crosses over another one (the 100-day or 200-day)
Those crossover points are the times when traders try to determine if they’re indicating a reversal in a trend. To illustrate, let’s look at the Nasdaq Index.
As of market close on Oct. 6, the Nasdaq’s 50-day moving average sits above its 100-day, which in turn sits above its 200-day. So the shorter-term average is higher than the longer-term averages, indicating a recent upward trend.
However, on Sept. 27, the daily price of the index fell below its 50-day moving average, and on Oct. 1, it fell below its 100-day moving average. Two notable crossover points, they caught the attention of traders and investors because they could have indicated a reversal and, in this instance, possibly signalled a coming downtrend.
Support and Resistance
The next place we might look to for signals is support or resistance levels to determine if a security’s price will stay in a range. The resistance level is the higher point and a representation of recent peaks in price. The support level is the lower point and a representation of recent troughs in price.
The concept behind support and resistance is that they represent psychological thresholds of price movement. The presumption is that future prices will stop at these “barriers” and remain in a range between them.
But nothing is forever. So the real signal occurs when a security’s current price rises above the resistance level or falls below the support level and could serve as one method of confirming a trend.
Just as these levels are psychological, breaking through them has psychological effects and tends to accelerate the trend that is taking shape. (There are exceptions when this hasn’t been the case, but for instructive purposes I’m painting with a broad brush here…. Please take heed of all the disclosures.)
The last big indicator I’ll cover is volume. Meaning, the volume of trading on a security that represents how active buyers and sellers are at a given point in time. Volume is more of a secondary indicator rather than primary, but can be an important way to confirm a trend or to identify overbought or oversold conditions.
For example, extremely high prices paired with low volume on further rallies (fewer buyers) and high volume on intermittent declines (more sellers) could indicate overbought conditions. In other words, when prices have moved up considerably, volume can help determine if the buyers are getting tired (i.e., overbought). Conversely, extremely low prices paired with low volume on further declines (fewer sellers) and high volume on intermittent rallies (more buyers) could indicate sellers are getting tired (i.e., oversold).
Don’t Scratch Your Trigger Finger
The thing about technicals is that they can give us itchy trigger fingers. The other thing about technicals is that for the vast majority of investors, they should be viewed as inputs, not major decision factors. But understanding the terms and knowing what to look for on charts can be an interesting way to learn about market movements. We are all forever students.
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