Ch3. Stock Investing — Technical Analysis: Charts & Indicators
What Is Technical Analysis?
Technical analysis (TA) uses historical price and volume data to forecast future price movements.
Core assumptions:
- All known information is already reflected in the price
- History repeats itself (patterns recur)
- Trends persist until they reverse
Important note: TA is most useful as a timing tool for entries and exits; it works best combined with fundamental analysis, not as a replacement.
Candlestick Charts
Each candlestick represents price action over a specific period (day, week, month):
- Open: Price at start of period
- High/Low: Price extremes during period
- Close: Price at end of period
Bullish (green/white): Close > Open — buyers won Bearish (red/black): Close < Open — sellers won
Key patterns:
| Pattern | Signal |
|---|---|
| Hammer | Potential bottom reversal (long lower wick) |
| Shooting Star | Potential top reversal (long upper wick) |
| Doji | Indecision; possible trend change |
| Bullish Engulfing | Strong reversal up |
| Bearish Engulfing | Strong reversal down |
Moving Averages
Moving averages smooth price data to reveal the underlying trend.
Simple Moving Average (SMA):
- 20-day: Most-watched short-term trend
- 50-day: Medium-term trend
- 200-day: Long-term trend; major support/resistance
Golden Cross: 50-day SMA crosses above 200-day SMA → bullish signal
Death Cross: 50-day SMA crosses below 200-day SMA → bearish signal
RSI (Relative Strength Index)
RSI measures momentum on a 0–100 scale.
- RSI > 70: Overbought → potential pullback
- RSI < 30: Oversold → potential bounce
- RSI ≈ 50: Neutral; trend-following conditions
Divergence: RSI making new highs while price makes lower highs (or vice versa) = powerful reversal signal.
MACD
MACD = 12-day EMA − 26-day EMA
Signal Line = 9-day EMA of MACD
Trading signals:
- MACD crosses above Signal Line: Bullish entry signal
- MACD crosses below Signal Line: Bearish signal
- MACD histogram growing: Momentum strengthening
Support and Resistance
Support: Price level where buyers consistently emerge to halt a decline
Resistance: Price level where sellers consistently appear to halt an advance
Key principle: Once resistance is broken, it often becomes new support (role reversal).
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