Comprehending the Stock Market through Technical Analysis (Part Two): Indicators and Patterns

An untrained eye, when glancing at stock market charts, will only see random movements from one day to the next. For trained analysts, these movements are patterns that they can use to predict the future movements of the stock prices. There are over a hundred different indicators and patterns that can be applied to technical analysis. There is no such thing as a single reliable indicator but investors can be quite successful when it comes to predicting price movements.


The Cup and Handle is one of the most popular patterns in stock market price movements. The cup represents the movement of the prices that starts relatively high then dips quite low and comes back up. The prices level out for a period before making a breakout. This period, which indicates a sudden rise in price, is represented by the handle. Buying on the handle usually generates good profits.

The bearish pattern that indicates the substantial fall of prices after a dip and a rise is called Head and Shoulders. This pattern starts with a peak called the first shoulder that is followed by a dip and a higher peak called the head. It is followed again by a dip and a rise that is now called the second shoulder.


Moving Average
The moving average is the most popular stock price movement indicator. It shows the average price over a period of time. The most common averages used in this indicator are 20, 30, 50, 100, and 200 days. For a 30-day moving average, the closing prices for each of the 30 days are added before they are divided by 30. Longer time spans are considered to be less affected by the daily fluctuation of prices. A moving average is plotted as a line on a graph of price changes. Prices that fall below the moving average have a tendency to keep on falling while those that rise above the moving average have a tendency to keep on rising.

Relative Strength Index
The relative strength index (RSI) is an indicator that uses a comparison between the number of days a stock finishes up and the number of days it finishes down. It is calculated for a certain time span that is usually between 9 and 15 days. The calculation of the RSI starts off by dividing the average number of up days by the average number of down days. The quotient is then added to one and their sum is divided by one hundred. The result is then subtracted from 100 because the RSI is expressed in a number that is between the 0 and 100. An overbought stock that is due for a fall in price can have an RSI of 70 or above. An RSI that is below 30 indicates a stock that may be oversold. RSI numbers are not absolute and they can vary depending on whether the market is bearish or bullish. An RSI that is charted over long periods of time has the tendency to show less extreme movements. A look at the historical charts over a period of a year or so is one way of comprehending how a stock price moves in relation to its RSI.

Money Flow Index
While the RSI is calculated by following stock prices, the money flow index (MFI) is determined by taking into account the number of traded shares and the prices of the stocks. Like the RSI, the MFI range is from 0 to 100. An MFI of 70 indicates selling while an MFI of 30 indicates buying. When charted over longer periods of time, the MFI can be a more accurate indicator.

Bollinger Bands
Bollinger bands are indicators that are plotted as a group of three lines. The upper and lower lines of the Bollinger bands are plotted according to the volatility of the market. A volatile market is represented by a wide space between the lines. The lines come closer together as the volatility lessens. The simple moving average between the two outer lines is represented by the middle line. A movement of prices closer to the lower band is a strong indication that the stock is oversold and that the price will increase soon. As prices rise to the higher line, the stock becomes more overbought that its prices will begin to fall. Investors use Bollinger bands to confirm the credibility of other indicators. Skilled technical analysts will always use a couple of indicators before making a decision of whether to trade a particular stock or not.

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