When it comes to figuring out when to buy a stock, there are two main schools of thought: fundamental analysis and technical analysis. Fundamental analysis involves all the material aspects of a company: its sales, revenue, profits, and so on — the day-to-day details of operations. Technical analysis, on the other hand, involves only looking at charts. A stock chart is a visual representation of the price movement of a particular security over time.
Using different mathematical technical indicators, it’s thought that traders can sometimes anticipate future price movements based on previous patterns. And fundamentals need not be at odds with technical analysis — the most successful investors often use both methods.
Below, we’ll look at five common bullish indicators used in technical analysis and discuss how they can be used to determine a reasonable time to buy a stock or ETF.
Technical Indicators of a Bull Trend
Before getting into the specifics of technical analysis, it’s important to understand the difference between bullish indicators and bullish patterns.
Indicators represent information generated by a computer based on a dataset. That dataset comes from the price action of a security over a set time period (one hour, one day, one month, six months, one year, etc.).
Patterns, on the other hand, are identified by human eyes when charts take on a certain shape (head and shoulders, cup and handle, etc.). Some traders even program their own computer scripts to try to identify patterns automatically, leading to a kind of hybrid of patterns and indicators.
All of these methods are broadly referred to as technical analysis — the process of using charts to try to predict which way a security will move next. A pattern or indicator that tends to appear when prices are getting ready to move higher is referred to as a bullish one.
Here are five examples of bullish indicators and bullish patterns.
RSI Weakness
The Relative Strength Index (RSI) is a technical indicator that gives investors an idea of how overvalued or undervalued a security might be. This momentum indicator gauges the significance of recent price changes. The higher the RSI, the more likely the stock is overvalued, and the lower the RSI, the more likely the stock is undervalued.
The RSI is represented by a simple line graph that goes up and down between two extremes (also known as an oscillator). When the line dips below a certain level, it can indicate potential undervaluation. Meanwhile, when it rises above a certain level, it can indicate — you guessed it — overvaluation.
RSI values range from 0 to 100 but rarely fall below 20 or go higher than 80. Between 30 and 60 is a shaded area sometimes referred to as the “paint” area. An RSI within this range can still provide some insight, but it is not as reliable an indicator as an RSI that has extended to more extreme levels.
An RSI of 50 is considered neutral, whereas an RSI of 30 and lower is considered undervalued (bullish). Meanwhile, an RSI of 70 and above is considered overvalued (bearish). In other words, the lower the RSI, the more of a bullish indicator it could be.
Cup-and-Handle Pattern
The cup-and-handle pattern is among the most bullish patterns known to stock traders. There are two main parts, as the name implies: a cup and a handle.
The cup is formed when a stock moves downward, then sideways, and then upward. Once the cup has been formed, the handle can be formed by a period of slow decline. This kind of price action leads to a chart with one part resembling the bottom half of a circle (cup) followed by a slanted line at the top edge (handle).
The pattern has a long list of nuances. Many lengthy articles have been dedicated to the cup-and-handle pattern alone. Here are quick notes about identifying the pattern:
• Ideally, the cup should be about 30% deep (having declined about 30% from its start to its lowest point).
• The handle should form over a period of at least five days to several weeks.
• Trading volume should surge when the handle finishes forming, at which point traders will often seek to enter into a position.
• Conversely, an inverted cup and handle can be a sell signal. This pattern has the same shape, only it appears upside down, with the handle slanting up and the top half of a circle forming the cup.
Moving Average Golden Cross
Moving averages (MA) are another common technical indicator. A moving average is the mean of a stock’s daily closing price for a certain number of trading days. Moving averages smooth out the trend of a stock’s price and highlight any moves above or below the trend.
A moving average is denoted by a line that overlays on a price chart. While these averages don’t contain a whole lot of information in and of themselves, sometimes key averages interacting with one another can serve as major buy or sell signals.
The 50-day MA and the 200-day MA are of particular importance when they cross paths. Most of the time, the 200-day MA will be higher than the 50-day MA. But when the 50-day crosses above the 200-day, the move can be seen as a bullish indicator signifying a trend toward upward price movement.
This indicator is known as the “golden cross,” and it is regarded as relatively rare and reliable. Prices often, but not always, move up after a golden cross happens.
Golden crosses can occur with moving averages of time frames shorter than 50 or 200 days as well, but longer time frames carry more weight.
Bollinger Bands Width
Bollinger Bands combine a simple moving average with an additional metric — a measure of price extending one standard deviation above or below the average.
When Bollinger Bands get very close together, it often indicates that a trend change lies on the immediate horizon. That means the price might be likely to break out either higher or lower in the near future in most cases.
While this indicator is a little vaguer than the others, combining it with a few other bits of information can sometimes make it a bullish indicator.
For example, an investor might choose to look at Bollinger Bands alongside one of the other indicators mentioned here. If the RSI for a particular stock were at 40 at the same time that Bollinger Bands were close together, that might give an investor further assurance that an upward move could be on the horizon.
Piercing Pattern
The piercing pattern is simpler than most others. It marks the possibility of a short-term reversal from downward price action to upward price action based on only two days of trading.
The pattern occurs when the first day opens near its high point, closes near the low, and has an average or larger-than-average price range. Then the second day begins trading with a gap down, opening near the low and closing near the high. The close ought to form a candlestick covering at least half of the length of the first day’s red candlestick.
A piercing pattern rarely appears in perfect form. As with other patterns, the closer to perfection the setup looks, the more likely it is to be accurate. When bullish patterns like this one coincide with other bullish indicators, like a low reading on the RSI, the potential for price gains becomes strengthened.
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Other Technical Analysis Factors to Consider
It’s important to remember that technical indicators should be used together when possible. Looking at only one indicator may not always give as accurate a picture of which direction price action will head next.
Another concern is time frame. These indicators and patterns need to be looked at over a sufficient amount of time to prove effective — the longer the better, in general. Looking at price movements on a daily chart might lead to one impression, but zooming out and looking at six months or a year might result in a different (and often more accurate) assessment for the simple reason that there is more data included.
Finally, when thinking about bullish patterns and indicators, realize that most investors have access to the same public knowledge. When a bullish development occurs, millions of stock traders use technical analysis to try to identify the pattern at more or less the same time. This can lead the charts to become self-fulfilling, as everyone can buy at the same bullish point or sell at the same bearish point, regardless of anything else happening.
The Takeaway
Technical analysis, which involves only looking at stock charts, is one of the two main schools of thought when it comes to figuring out when to buy a stock. Investors using this form of analysis may look at both bullish indicators and bullish patterns to determine when it appears that prices are preparing to move higher. There are a number of these patterns and indicators investors might look at — from RSI weakness to piercing pattern — though it’s generally best to use technical indicators together and also take time frame into consideration.
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