Basic Technical Analysis

Bar Charts, Trend Lines and Moving Averages

Feb 21, 2009 Karen Gibbs

In the absence of strong fundamental factors, investors often turn to technical analysis to anticipate what is likely to happen, based on past events.

If enough investors subscribe to the belief, it becomes a self-fulfilling prophecy.

Bar Chart

The most basic tool of technical analysis is the bar chart. This chart displays basic market price data over a defined period of time. Daily bar charts note the open, high, low and closing price of an asset. Rising vertically, the bar marks the high and the low of a given time period, with the starting price marked by a horizontal line, or tick, to the left and the ending or closing price marked by a tick to the right.

Support and Resistance Levels

Using the information used in bar charts, investors can determine support and resistance levels along with a point at which prices are said to pivot. Adding the high, low and close data together and dividing by three will yield the level at which an asset is said to pivot. Initial support levels can be calculated by subtracting the difference between the high price and pivot from the pivot point. Initial resistance will be encountered when the difference between the pivot and the low is subtracted from the pivot point. Entry and exit points can be triggered when asset prices fall to support or rise to resistance.

Trend Lines

Connecting two or more points and extending the line into the futures creates a trend line. A positively sloped uptrend line can connect two or more low points or two or more high points. Positively sloped high and low trend lines together create a channel. When prices remain above a trend line, investors have confidence in the uptrend. It is considered a bullish sign, especially if accompanied by rising volume. Conversely, connecting two successively lower high points and extending into the future creates a negatively sloped trend line and is seem as a bearish indicator. As long as prices are trading beneath the negatively sloped trend line, investors expect prices to continue to decline.

Volume

The number of trades transacted at a certain price or time period is considered volume. It is a measure of demand or lack of demand for a certain asset at a given time and/or price. It is also a measure of how liquid a market is for a given asset. More liquidity means the more efficient the market, with bid and offer prices competitive and less volatile.

Moving Averages

Moving averages can smooth data over a given period of time, helping investors to spot trends. The most common moving average is calculated by using closing prices. Simple moving averages are calculated by adding the most recent closing data and dividing the sum by the number of data points. To determine a five-day closing moving average, total all five closing prices and divide by five. Adding the latest data point and dropping the first will create a rolling moving average. Connecting the averages creates a graceful, curving line. Moving averages are, by definition, lagging indicators and follow a trend. Different moving average time-lines can be overlaid, illuminating buy and sell opportunities when the shorter moving average line intersects the longer moving average. A cross to the upside can indicate a buying opportunity, while a cross to the downside may initiate a sell signal.

As with most investment metrics, technical analysis should not be used as the sole rationale for investing, but in addition to other data collected to enhance the performance of a portfolio and obtain overall investment objectives.

The copyright of the article Basic Technical Analysis in Investment is owned by Karen Gibbs. Permission to republish Basic Technical Analysis in print or online must be granted by the author in writing.

Dow Chart with Volume