Why Technical Analysis? (Building a Foundation for Profitable Trading)

Many years ago, technical analysis was considered ‘hocus pocus’, and serious investors and traders based their decisions off fundamental analysis only.

In today’s market, fundamental analysis is still widely used among very successful investors, and is an excellent strategy to use in the right market conditions, but technical analysis has made it’s entrance and created a presence not to be trifled with.

What is Technical Analysis?

First of all, what exactly is technical analysis, and what is behind it?

Technical analysis refers to the study and use of information related to stocks and the market in general. Technical analysis (TA) is a combination of charts, bars or candles, graphs, indicators and other symbols which represent to the person reading it the price, volume, momentum, trendlines, averages and other useful information related to a stock which can be used in making trading decisions.

But behind all of that data lies the true source of technical analysis- people. The market is simply a collection of individuals who are buying and selling. Fluctuation in price which is represented on a stock chart is nothing more than a reflection of the nature and mass sentiment of the individuals who are buying and selling. It is a reflection of human nature.

By learning the art of TA, we can discover repeating patters in human behavior that occur over and over again, and acquire the skill to profit from fluctuation in price.

Start the Basic Technical Analysis Course today. Not a member? Sign up for 14 days free.

Short vs. Long Term Investing

Technical analysis is geared more toward the short term, while Fundamental analysis tends to be more long term. But using TA can help you in deciding what market conditions are like and if the are favorable for ‘buy and hold’ or ‘holding for the long term.’

For example, many people made a lot of money buying and holding stocks, until about a year ago when the market began to turn. At that point they began to lose money on the stocks that they were holding, and those losses have continued to increase to date.

With a simple understanding of Technical analysis, many of those losses could have been prevented, or at least significantly reduced. One client had a 401(k) through his employer. He had already lost significants amount of money before signing up with our education.

By learning a little bit about TA, and how to read moving averages and other indicators, he gained the confidence to make an educated decision about his retirement account. He decided that he would exit his current stock and mutual fund positions, keeping his 401(k) in cash (in his account, so he received no penalties, but not invested in any securities).

Over the ensuing weeks he saved over $72,000 that he would have otherwise lost had he remained invested. Needless to say he was a happy camper. He is now using the knowledge he is learning to make money in the current market conditions, allowing him to not only stop losing money, but to begin making it as well, placing him light years ahead of his co-workiers in his investment portfolio.

High Probability Trading

Technical analysis allows traders and investors to read the markets (the sentiment of individuals), and only put their money to work in the market when the chances for success are increased.

When analyzing charts, a trader is looking for the highest number of factors suggesting that a significant move in one direction is possible (higher odds), enough to lead to an acceptable risk/reward ratio.

Everything to do with TA is designed to increase the odds of success in trading. It’s a tool to determine that the reward for investing outweighs the possible risk.

It’s Not About Prediction

Despite what many people believe, TA is not about predicting the future. In reality, it has to do with probability, not prediction. TA helps us to find a many factors as possible that indicate a probable up, down or sideways move in the market.

Even a basic understanding of TA can help even the most steadfast of Fundamental Traders. There are traders who trade only on technicals, but there are not many traders any more that, fundamentalist or not, that do not use some technicals as a part of their trading strategy.

Start the Basic Technical Analysis Course today. Not a member? Sign up for 14 days free.

What To Do if You’re Attacked by a Bear (Market)

Written by Rachel Denning for www.InvestTide.com

“Buy and Hold” have replaced “I love you” as the three most popular words in the English language.

Jim Grant

A national park brochure advises visitors: “If you are approached by a bear, try to look big. Be forceful, but not aggressive. Keep your pack on, wave your arms, talk loudly. Back away slowly, but DO NOT RUN. If a bear attacks you, assume the fetal position and protect your vital organs.”

This seems to be the standard procedure for most investors who are facing a bear market. Try to look big, be forceful. Keep your pack on (don’t sell anything, in fact, buy more), wave your arms, talk loudly about how it will go back up, sometime. DO NOT RUN. If the bear attacks your retirement, assume the fetal position and protect your vital organs.

I’m sure you’ve heard the philosophy preached from every one including your broker and his dog- buy and hold, dollar cost average, hold for the long term. Who hasn’t heard that? It’s an investing article of faith that if you hold for the long run, you can’t fail to profit in the end. Or can you?

What is the definition of ‘long term’ anyway? How long is it? The answer may be surprising. In fact, you might have to be Methuselah to reap the profits of the long term. Brilliant economist, who unfortunately wasn’t brilliant enough to avoid losing millions in the bear market of 1929-1932, said this: “In the long run, we’ll all be dead.”

Acres of cemeteries were filled with investors who died waiting for their stocks and mutual funds to break even after the Great Decline of ‘29. Seniors who invested in 1929 died long before their heirs ever broke even on their inheritance.

One middle aged man got in near the top in 1929, and held on for the ‘long term.’ He held on through Herbert Hoover, four terms of Franklin Roosevelt, Harry Truman, and two years of Eisenhower. Then it was time to retire. The capital gains he had to show for all his years of patience? Zero. Zilch. Nada.

Some consider the Great Decline to be a financial fluke, and that the market could never again experience an 89% loss like it did then. However, year-to-date, from it’s high in October 2007, the S&P has lost 52% of it’s value (in one year’s time).

Even when the market is not extremely bearish, buy and hold for the long term is still not the best philosophy. Consider these examples with the Dow:

• Climbed to 194 in 1937. Twelve years later in 1949, it was lower than that
• Topped out at 685 in 1959. Sold for less 17 years later in 1974
• Record territory at 734 in 1961. Sold for exactly the same price 19 years later in 1980
• It reached 11,500 in 2000. Today, almost nine years later, it just hit 8,000

It has been figured that it takes seven and a half years for stocks purchased at the onset of a bear market to return to a break even status. In a worse than average bear market (like the one we’re in now) it takes even longer.

Buying and holding is far from the safe investment strategy that it is made out to be. It works, in bull markets. It works in mild bear markets, that are quickly reversed. Other than that, it is risky, extremely risky.

You’re most likely holding on to stocks that are exceedingly overpriced, that won’t return to their previous highs for a decade or more. This is risky if you’re planning on a road trip in the RV in ten years or less.

Even Warren Buffett, king of investors, has a point at which he’ll sell. In 1969, stock reached an extravagant high, Buffett found nothing worth owning, so he sold everything in his portfolio, and gave his partners their money back. For the years during the bear market that followed, Buffett was in cash. He didn’t return to stocks until four years later, when he got an excellent price.

The unfortunate ones who ‘held for the long term’ had to wait through four presidencies to see a profit. In the meantime, Buffet became a billionaire.

Now ask yourself, if Warren Buffet has a selling point, don’t you think you should hav a selling point? Buy and hold, yes, if and when it makes sense. But when you’re under attack by a viscous mama bear (market), can you afford to hold on to the bitter end? Will you even live that long? The best advice under such circumstances is to cut your losses and run!

An example of how well this strategy works is illustrated by the story of a client. He had a 401(k) retirement plan through his company. He had already lost some money in it since the start of the decline a year ago. He was advised through our personal coaching program to ‘go to cash’ in his retirement, meaning that he sell his stock holdings and keep the money in cash in his 401(k) account.

To date, he has saved over $72,000 in losses. These are losses he would have incurred had he continued to cling to the ‘buy and hold’ mentality. Many of his co-workers continued to hold, and have incurred substantial losses as a result.

He is now learning and applying strategies that he can use to make money during this volatile bear market. Having saved $72,000 in losses, and now learning strategies that will create more money while others contine to lose, now places him light years ahead of his peers.

Many believe that it is too ‘risky’ to exit their stocks when the market is dropping, but really, which is the riskier philosophy? To hold on out of fear, or to take action that results in avoiding losses and creating profits?

Action Steps

1. Realize that “a Dow that goes up must come down.” Bear markets will happen, and most likely when you’re ready to retire! Decide to learn strategies that allow you to profit from bear markets.

2. Commit to using a buy and hold strategy only when it makes sense. Be flexible enough to change that strategy when the market changes.

The Mortgage of the Rich

I learned this while taking an investment seminar by Robert G. Allen, (best-selling author Nothing Down, Multiple Streams of Income and Creating Wealth). This is the mortgage strategy of the rich.

Say you want to purchase a $300,000 home. If you were to get a 30 year fixed rate mortgage at 7.5%, your payment would be about $2100 per month.

Now let’s say that instead of the 30 year fixed you were to get an interest only mortgage, the interest rate is generally two points lower, so your interest on your $300,000 loan would be 5%, and your monthly payment would only be about $1250.

Remember, this payment is interest only, so at the end of 30 years, you would still owe the principal balance.

But, here is what the rich do. They take the difference between the $2100/month fixed loan and the $1250/month interest only loan ($850) and they ‘pay’ that amount to themselves, instead of to the bank. The invest it into a vehicle that provides them a rate of return, thereby increasing their own wealth rather than the wealth of the bank.

Here is what would happen. If they take the $850 monthly difference($10,200 per year) and invest it (into stocks, mutual funds, options, ETF’s), receiving an annual average rate of return of 7%, at the end of 30 years, they would have $1,043,024.00! Not bad.

They would then be able to pay off the $300,000 principal amount, and have a remaining $743,024 to continue investing.

Compare this to the first option with the 30 year fixed mortgage. In that scenario, you end up paying a total of $752,804 for your home, $452,804 of which is interest! The principal ($850) is paid to the bank each month, which they have used to invest with and made millions on. You in turn only have a home worth whatever the market value is (maybe $750,000, maybe $300,000, which you would have to sell or get another loan on to access the equity).

In the second scenario, the interest only loan, you are paying the same amount ($750,000- a total of $450,000 in interest, plus the $300,000 cost of the home), but you will have the home with all it’s equity value ($300,000 or $750,000??), plus you will have the $743,024 from the investment of your ‘principal’ (the $850/month).

Now, there is a caution to this tale. This plan will only work if you 1) have discipline to invest the difference in payment amounts rather than spending it every month, and 2) you have the knowledge to invest the money in a wise way that will produce a reasonable rate of return (but even at 1% you would have $356,981 at the end of 30 years, so you would still win.) If you don’t have those two things, then an interest only loan would only put you in a worse situation at the end of 30 years.

The great news is: you can learn both of those skills if you do not already have them. Discipline is a habit that can be cultivated, and investing is a skill that can be acquired.

(Oh, and by the way, many investors consider 15% per year to be a minimum return. Do the math on that one)

You can do the math for yourself on these scenarios-

Mortgage Calculator (Please note I did not include property tax or PMI for the above examples)

Amortization Calculator

Compound Interest Calculator

Interest Only Loan Calculator

For developing discipline I recommend:

Click here to read a summary

For learning how to invest I recommend:

Also, a very excellent resource for retirement planning and stock market investing:

The Stock Market Report

They charge a monthly membership fee for their ‘advanced’ courses, but they have a lot a good free information

Trading Books

More books for my To Read list- these are about trading:

Crowd Psychology

Alexander Elder suggests studying the psychology of crowds to understand why masses make the decisions they do and how it affects the market. I’m adding some books to my To Read list that deal with crowd psychology:

I’m not sure if this one is about crowd psychology or word-of-mouth marketing, but it’s been on my list for awhile.

The Tipping Point by Malcolm Gladwell