Saturday, February 2, 2008

Simple Rules for Analysing Stock Charts

Some people have started becoming bullish now. Fundamental analysts have started saying that markets are fairly valued now and valuations have now reached at 2004 levels. But there are still many who continue to be bearish and say that the worst is still not yet over and there may be a retest of last week’s lows. I personally feel that after such a deep correction, the confidence of a lot of people has been shaken up and it will take time to build up that kind of confidence again. So we may just consolidate between 4500 and 5500 (Nifty) for sometime. The markets do go up now but with low volumes and there is a lot of selling coming in at higher levels. This is what happened yesterday. The markets did go up but with dry volumes. There was no strength in the move as far as the volumes are concerned. We can expect the volumes to increase once the crucial level between 5500-5600 is crossed.

Generally, those who have lost the confidence in the markets (because of the recent fall) do not enter at these levels. They keep waiting till the markets improve and till they feel that nothing could go wrong now. And then they enter. In fact that is the time to sell. The correct time to buy is now. Invest when the markets are beaten down, when the valuations are low and when there is panic in the markets. Be a contrarion to the general public. That is the way to make money.

My technical software is not working today and there are no charts to see and analyse and give my inputs for Monday. However, for all of you who want to learn to look at charts, I’ve consolidated a few simple rules which anybody could apply.

Though, you really do not need a charting software (there are so many charts available online) but you do need to study them. Apply a few simple rules and you are ready to go. But there will be some people who would like to buy a software and study everything in detail. Whenever you buy a charting software, it will come equipped with all the technical analysis tools and indicators. Many of you would have gone through some technical analysis books and would be raring to have a go at analyzing charts with one indicator, and another, and another and yet another.

Well, that is the first step to go the wrong way. The most important rule to remember while analyzing charts is that you have to keep them simple. Remember: “Too much of analysis leads to paralysis.” The best way to study charts is to apply only one or two rules/indicators or at the most three. My personal favorites are trendlines, RSI and MACD.

For those who just want to do it as fun and learn without any real investment in a software, here are a few simple rules you can apply.

Dow Theory: This theory was given by Mr. Charles Dow in 1931. He was the man who started it all. He used to say that stock prices move in trends and one should buy when the trend is up and sell when the trend is down. His definition of an uptrend was when the price made a higher low and then a higher high. Similarly, a lower high and a lower low signified the beginning of a downtrend. This theory can be applied to charts of all time frames.

Trendlines: Trendlines are those lines which connect at least 3 lows or at least three highs. An uptrending line should be drawn by connecting the lows and a downtrending line should connect the highs. The signal that one gets from trendlines is the breakthrough of prices. When prices penetrate an uptrend line, it is time to sell and when they go through a downtrend line, it is time to buy.

Moving Averages: Moving averages, in short, are moving trendlines. You simply calculate the average of the closing prices of the last x days (depends on what period you want to choose. Most common are 10, 21, 50, 100 and 200) and that is the value of the moving average for the last day. And you will be surprised to see how regularly prices find support/resistance at these levels.

For more indicators, it will become too complicated to calculate yourself and it would be best to buy a charting software and then we can probably hold a meeting/seminar and go into the details of analyzing charts. But one should remember that there is no such thing as a PERFECT INDICATOR. It does not exist. But it does not mean that indicators don’t work. All indicators are good and all indicators give very good signals. You just have to be consistent using them.

I hope this article was of some help to all of you. Do leave a comment in case you would like more such articles on a regular basis. Also leave a comment if you don’t like the article and would prefer not to be disturbed with such topics which don’t have any recommendations.

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