3 Best Technical Indicators on Earth

by Louis Basenese Chief Investment Strategist, Wall Street Daily

THE

3 BEST

TECHNICAL INDICATORS ON EARTH “Those who cannot remember the past are condemned to repeat it.” This oft-quoted warning also forms the basis for technical analysis. Only I’d tweak it to say, “Those who do remember the past are likely to profit from it.”

THAT’S TECHNICAL ANALYSIS IN A NUTSHELL. After all, technical analysis is based on the idea that all the information is represented in price and volume. So by comparing what’s happening in the market today to what’s happened in the past, you can tell what will (most likely) occur in the future.

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In other words, while fundamental analysis involves screening businesses’ balance sheets, earnings reports and economic conditions to try to predict stock returns, technical analysis relies on the participants in the market to distill all that information into meaningful data. And by watching price and volume, you can interpret the emotions driving the market.

Some believe that technical analysis is simply about drawing lines on a chart – and that it’s essentially the equivalent of financial astrology.

Hogwash!

Granted, some methods have failed to produce real returns. And I agree that not all technical indicators are worthy of your attention. That’s why it’s important to focus only on the key indicators that have proven successful – time after time. Lucky for you, we’ve found the top three, best of breed, technical indicators that you can use to maximize your profits. Here’s a brief rundown of each…

INDICATOR #1:

MOVING AVERAGE CONVERGENCE/ DIVERGENCE (OR MACD) The MACD indicator is a great introduction to technical analysis because it’s based on one of the easiest, most powerful concepts: the moving average.

Calculating and drawing a moving average line is simple. It’s just the average price of a stock over a number of days, usually 50 or 200.

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A stock trading above this line is a strong bullish indicator by itself. But you can take a moving average to the next level by tracking when moving averages of different lengths of time cross paths. Take a look at the chart for Under Armour (UA) to see what I mean.

When the 50-day moving average crosses above the 200-day moving average, it means the stock is likely going to see a big move higher.

Basically, MACD takes moving averages, fine tunes them and combines them into a single indicator. It just takes a few more steps…

1)



First, instead of a 50- or 200-day moving average, MACD uses 12 and 26 days. It also focuses specifically on the “exponential moving average,” which means more weight (and importance) is given to the most recent stock prices.

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2) T he next step is creating the “MACD line,” which is simply the

difference between the 12- and 26-day exponential moving averages from step one.

3) O  nce that’s done, the “signal line” is created. That’s the nine-day exponential moving average of the new MACD line.

If this sounds complicated, keep in mind that you don’t really need to know how the lines are created. The important part is how they interact. Check out the following chart of Bank of America (BAC) to see what I mean.

There are two main things you need to watch for…

1)



When the MACD line jumps above zero, it shows that the current momentum is positive. And when it drops below zero, momentum is negative.

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2)



Most important, you can identify when these shifts in trajectory are likely to occur. It’s all about watching when the lines cross over each other.

When the MACD line crosses above the signal line, momentum is about to turn positive. And when the signal line jumps higher than MACD, it’s a sign that the share price is about to dip.

The chart indicates the bullish points with green arrows and the bearish patterns in red. Sure enough, the stock movements (mostly) correspond with the “Buy” and “Sell” signals. The trick is to spot the crossovers as close to the zero line as possible. That’s where the strongest signals occur.

INDICATOR #2:

When the MACD line crosses above the signal line, momentum is about to turn positive. And when the signal line jumps

higher than

MACD, it’s a sign that the share price is about to dip.

PARABOLIC SAR Don’t let the imposing name fool you. Parabolic SAR is dead simple to interpret.

SAR stands for “stop and reverse,” meaning that it’s designed to find turning points in stock trends. In short, Parabolic SAR captures momentum.

The indicator is typically drawn as dots that follow a stock chart.

When the dots are below the price, the momentum is positive, like the dots are pushing the stock up. When the dots are above the price, momentum is negative.

In simplest terms, when the dots switch from above the stock price to below, that’s a clear “Buy” signal. On the flip side, when they switch from below the price to above, it’s a “Sell.”

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You’ll also notice that the dots tend to converge with the stock price right before they switch sides. So the closer the dots get to the share price line, the sooner the current share price direction is likely to reverse. So not only does Parabolic SAR identify the turning point, it shows how much time you have to invest accordingly. Simple, right?

There’s one trick to using Parabolic SAR, however. You need to be selective about your “Buy” signals.

You see, if a stock is trading within a narrow range, the dots will give off multiple “Buy and “Sell” signals in rapid succession. That’s not a formula for making money. The Symantec (SYMC) chart below shows what I mean.

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When the stock traded in a tight range between June and August, there was a flurry of signals that wouldn’t have been profitable. But between January and March, the signal worked well. To reconcile this, verify that the overall stock market is trending in a similar direction, too, and not staying stagnant. Of course, you could pair the MACD line with Parabolic SAR to double check your findings.

INDICATOR #3:

MONEY FLOW We already know there are two sides to every stock trade – the buyer and seller.

With a

stronger grasp

of investor sentiment about a particular stock, you could pick your “Buy”

and “Sell”

levels with more confidence.

But wouldn’t it be nice to know what’s going on behind the scenes? That is, whether the buyers or the sellers are more eager to act? With a stronger grasp of investor sentiment about a particular stock, you could pick your “Buy” and “Sell” levels with more confidence.

That’s what the Chaikin Money Flow tries to capture. It indicates “buying pressure” and “selling pressure.”

The Chaikin Money Flow takes positive and negative periods for a stock, then multiplies them by the volume of trading over that time. This assigns greater weight to days when there was heavy volume.

Then it compares the ratio of positive pressure to negative pressure and converts that to a value between -100 and 100 (or between -1 and 1 on some software). At that point, you chart it as an additional line under the stock. When Money Flow is high, it means the stock has more buying

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pressure than selling pressure – and vice versa.

Now, you may be tempted to use this as a trend indicator. So you’d buy when there’s a lot of buying pressure.

Money Pinpoints When Stocks Money FlowFlow Pinpoints When Stocks Are for Dueafor a Reversal Are Due Reversal MorganMorgan StanleyStanley (NYSE:(NYSE: MS) MS)

Nov

Nov2012 Dec Feb 2012Mar Feb Apr Mar May Apr Jun May Jul Jun Aug Jul Sep Aug Oct Sep Dec

Source: RightWayCharts.com Source: RightWayCharts.com

21 20 19 18 17 16 15 14 13

21 20 19 18 17 16 15 14 13

25 0 25

25 0 25

Oct

www.wallstreetdaily.com www.wallstreetdaily.com

But Money Flow actually identifies when a stock is overbought or oversold. As a result, it shows the end of the trend (or a reversal point). In other words, it’s more of a contrarian indicator. When the rating is high, it means there may be too much buying pressure and the stock is set to collapse.

On such merits, when the Money Flow passes a critical level (25 or -25 is a good rule of thumb) and stays there for a while, it’s a sign that a reversal is imminent. (An indicator called the Money Flow Index is very similar to Chaikin Money Flow, with only a slight change in the calculations. You can

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interpret the signals the same way.)

Bottom line: Combining these three simple indicators can create a powerful system for identifying when stocks are likely to rise or fall. You don’t need a math degree. Heck, you don’t even need to understand the formulas to use these indicators to boost your investment profits.

You just need to look at a few charts until you can see the patterns repeating themselves. After all, that’s the basis of technical analysis.

The chart says it all.

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