Stock Introduction Part 2: Technical Analysis (Technical Analysis)

Besides Fundamental Analysis - Fundamental Analysis in last week's article, Technical Analysis (Technical Analysis) is also one of the most popular analysis schools in the current market.

Technical Analysis relies on technical charts (time series) of stocks/derivatives to forecast future price trends without considering the intrinsic value of the stock.

Technical analysis based on the foundation Dow Theory, which states:

• Stock prices reflect all market news - including market sentiment towards those news.

  • For example: CEO dumping shares, company incurring losses,…

• Predict stock prices based on price and trading volume.

Part 2 of the Introduction to Stock Analysis series, Viet Hustler will introduce the basics of Technical Analysis - along with the 3 most basic indicators in this stock analysis school.

But first, Viet Hustler will distinguish the purposes of the two above-mentioned stock analysis methods:

Fundamental Analysis (Fundamental Analysis) vs Technical Analysis (Technical Analysis)

When to use Technical Analysis? When to use Fundamental Analysis?

It can be seen that Technical Analysis and Fundamental Analysis have different purposes and methods:

Technical Analysis (Technical Analysis) for active trader (full-time traders) - they frequently monitor changes in market sentiment (market sentiment) and bet on those frequent fluctuations.

Active traders can be divided into two types: day trader and swing trader.

• Day trader are traders who completely rely on market sentiment: they have trading frequency multiple times in a day and profit from price differences due to intraday market fluctuations.

  • Day traders mostly use Technical Analysis to anticipate market sentiment.

• Swing trader mainly bet on stock up and down trends over a period of time (a few days or a few weeks) so they have lower trading frequency.

  • Swing traders can combine both Fundamental Analysis and Technical Analysis.

Fundamental analysis (Fundamental Analysis) often used by non-full-time investors (usually position trader.)

• They don't sit in front of the screen every day to trade, but instead research and bet on the potential of a stock or an industry for long-term investment (therefore, most of them are long position traders).

• Therefore, Fundamental Analysis is more useful for them.

• Details at the article on Fundamental Analysis by Viet Hustler.

However, regardless of the trading position, the current popular trend is to combine both Technical Analysis and Fundamental Analysis in financial investing.

Introduction to Technical Analysis (Technical Analysis)

Technical Analysis is an investment method based on price fluctuations and trading volume of the market, mainly through the use of charts, to predict future price trends.

Technical Analysis is based on 3 main assumptions:

1. Price fluctuations and volume reflect all market information.

2. Prices move according to market trends.

3. History repeats itself.

Note: Technical Analysis is only suitable for short-term trading and investment short-term.

Price Trend: Elliott Wave Theory (The Wave Principle)

In technical analysis, investors need to identify the price trend (trendline). According to Ralph Nelson Elliott, a professional market trading researcher, the trading market follows repeating cycles, mainly due to investors' emotions being influenced by information + crowd psychology.

Elliott Wave Pattern complete will include:

• First 5 impulse waves (motive phase): subsequent lows higher than previous lows, subsequent highs higher than previous highs.

  • Waves 1, 3, 5: up.

  • Waves 2, 4: correction/down.

• 3 final corrective waves (corrective phase): subsequent peaks lower than previous peaks, subsequent lows lower than previous lows.

  • Waves A, C: down.

  • Wave B: up.

Elliott Wave Rules:

1. Wave 3 is not the shortest among waves 1, 3, 5.

2. Wave 2 does not correct too deeply from the formation point of wave 1.

3. Wave 4 never enters the price territory of wave 1.

Thus, by correctly identifying repeating patterns based on price, investors can predict the next price trend (trendline).

Support Zone and Resistance Zone

Support (Support) and Resistance (Resistance) zones are levels or limits where the stock price has fluctuated in the past.

There, the price will slow down or reverse before continuing the trend.

• Support Zone: the zone where many buyers appear.

  When the stock price falls to the support zone → buying pressure increases → the stock will reverse (from declining to rising).

  • Example below: very strong support price zone at $51.25 → The stock will have difficulty correcting downward too deeply from the $51.25 level!

• Resistance Zone: the zone where many sellers appear.

  When stock price hits resistance level → creates selling pressure → stock reverses and starts declining.

  • For example, $39 price zone was the resistance level for Amazon stock (March-November 2006 period) → Stock tends to reverse downward when hitting $39 price level.

Thus, identifying support zones and resistance zones forms the basis for technical investors to make appropriate buy/sell decisions, ensuring effective profit-taking and stop-loss.

Common Types of Technical Indicators

In Technical Analysis, there are many indicators used depending on each investor's style.

Technical indicators are calculated for the purpose of explaining relationships regarding:

• Selling and buying strength (stock supply/demand).

• Predicting the next price trend.

→ Investors can fully “catch the wave” (trendline) with any stock without being limited by knowledge of the company's financial situation like in Fundamental Analysis.

Below are the 3 most commonly used indicators in Technical Analysis.

When proficiently used, readers can somewhat independently form judgments about future price trends.

1. Moving Average (Moving Averages - MA)

Moving Averages are a popular technical indicator used to track stock price fluctuations over a period of time.

Investors use MA lines to:

• Identify price trends and reversals.

• Measure the strength of upward or downward momentum.

• Distinguish different time periods to observe momentum.

• Determine support and resistance levels for stop-loss decisions.

There are 3 common types of MA lines used in technical analysis:

• SMA Line (Simple Moving Average): simple moving average line

  • Calculated as the arithmetic mean of closing prices (Adjusted Close) over a specific period.

• EMA Line (Exponential Moving Average): exponential moving average line

  • Calculated using an exponential formula that focuses on the most recent price fluctuations.

    → EMA is sensitive to short-term fluctuations and detects unusual signals faster than the SMA line.

• WMA Line (Weighted Moving Average): linear weighted moving average line

  • Emphasizes parameters with the highest frequency of occurrence.

    → WMA heavily weights price steps with large trading volumes, focusing on money flow quality.

In this article, Viet Hustler will focus solely on introducing how to use SMA in technical analysis.

• Example: Tesla stock closed sequentially at 10 USD, 11 USD, 12 USD, 11 USD, 14 USD over 5 consecutive days.

  → Tesla's MA5 = ($10 + $11 + $12 + $11 + $14) / 5 = 11.6 USD.

Note on the lagging nature of the SMA line:

The SMA line is considered a lagging indicator because it follows already formed prices. Therefore, SMA has relatively low sensitivity to short-term fluctuations.

• For example, the actual price line peaks first, then SMA(20) peaks. SMA(50) will peak even later.

  → The longer-term the SMA, the higher the lag and the less it adheres to the price line.

Applications of Moving Averages:

• Common SMA lines:

  • Long-term MA: SMA(100), SMA(200)

  • Medium-term MA: SMA(50)

  • Short-term MA: SMA(10), SMA(14), SMA(20)

• Buy signal: When the short-term MA line crosses above the long-term line.

  • Price > SMA20 → Short-term uptrend.

  • Price > SMA50 → Medium-term uptrend.

  • SMA20 > SMA50 → Long-term uptrend.

  • Price > SMA20 and SMA20 > SMA50 → Clear price uptrend when the 3 lines cross upwards.

• Sell signal: When the short-term MA line goes below the long-term line.

  • Price < SMA(20) → Short-term downtrend.

  • Price < SMA(50) → Medium-term downtrend.

  • Price < SMA(100) → Long-term downtrend.

  • SMA(20) < SMA(50) → Long-term signal confirming long-term downtrend.

  • Price < SMA(20) and SMA(20) < SMA(50) → Clear downtrend when the 3 lines cross downwards.

2. MACD: Moving Average Convergence Divergence

MACD (Moving Average Convergence Divergence) is an indicator that helps stock investors determine buy/sell signals for a stock.

MACD is determined by the difference between the 12-day EMA and 26-day EMA lines.

Where, 9-day EMA is used as the signal line (Signal Line). When:

• Signal line and MACD cross → Signals price trend reversal → Investors can consider buy/sell points to execute trades.

  • MACD crosses above the Signal line → Buy signal.

• MACD crosses below the Signal line → Sell signal.

• After MACD crosses the Signal line, investors should observe the trend for another 3-4 days to confirm it is a correct reversal signal.

3. Relative Strength Index (Relative Strength Index - RSI)

The RSI (Relative Strength Index) indicator is an oscillator (a line oscillating between two bounds) from 0 to 100, where:

• Oscillation < 30 is called oversold → Signals upward reversal trend.

• Oscillation > 70 is called overbought → Signals downward reversal trend.

A stock is considered overbought when the RSI is above 70 and oversold when it is below 30.

The RSI indicator is calculated in 2 steps:

(1) Calculate the Relative Strength (RS) by dividing the average daily gains by the average daily losses in a cycle.

(2) Calculate RSI.

• In the neutral zone (RSI = 50), investors can consider it a support/resistance zone:

  • RSI falls from overbought zone to 50 → Support signal → Investors can consider buying.

  • RSI rises from oversold zone to 50 → Resistance signal → Investors can consider selling positions.

• Additionally, investors can use RSI = 60 or 70 as resistance, RSI = 30 or 40 as support => depending on the stock and the investor's risk tolerance.

CONCLUSION

Fundamental analysis and Technical analysis are two investment schools with different purposes and operating methods, in which:

• Fundamental analysis focuses on the growth potential of a company or industry based on intrinsic value (intrinsic values) of that company or industry.

  • Fundamental analysts seek companies trading at market prices below their INTRINSIC VALUE.

• Technical analysis based on fluctuations price and trading volume (reflecting market psychology) to predict future price trends.

So which investment school is 'NUMBER ONE'?

It's hard to say which investment method is the most effective. Each method has its own pros and cons. In practice, both methods have been proven in the market and delivered certain successes for investors.

Therefore, to find stocks with growth potential and determine suitable buy/sell points, investors can combine answers to two questions:

1. What is the company's value? Is the company's stock being sold below its value? (Fundamental analysis).

2. Is the stock in an uptrend? (Technical analysis).

thereby developing their own personal investment strategy.

References:

1. Drakopoulou J (2015), A Review of Fundamental and Technical Stock Analysis Techniques.

2. Dr. Sreemoyee Guha Roy (2013), Equity Research: Fundamental and Technical Analysis.

3. Adam Hayes (2023), Simple Moving Average (SMA): What It Is and the Formula.

4. Brian Dolan (2023), MACD Indicator Explained, with Formula, Examples, and Limitations.

5. Jason Fernando (2023), Relative Strength Index (RSI) Indicator Explained With Formula.

6. Adam Hayes (2023), Dow Theory Explained: What It Is and How It Work.

7. James Chen (2023), Elliott Wave Theory: What It Is and How to Use It.

8. CASEY MURPHY Casey Murphy (2023), Support and Resistance Basics.