Technical Analysis 101

In its simplest form, technical analysis is the study of price. From trendlines to stochastics, it focuses on patterns of price movements and other charting tools to evaluate a security’s strengths or weaknesses.

Why You Should Use Technical Analysis

There are two main reasons why everyone should use technical analysis: flexibility, because technical analysis can be applied to almost anything, and objectivity, because it focuses solely on the facts.

Technical analysis uses historical data to generate an outlook on a security. This means that it can be used on anything, including stocks, futures, commodities, fixed-income, currencies, and almost anything else that has reliable data.

Typically, you’ll hear about technicals on stocks, exchange-traded funds (ETFs), and indices like the S&P 500 or Nasdaq Composite. The bottom line is that once you learn how to use a few basic indicators, you’ll immediately improve your odds across almost any security.

My History with Technical Analysis

My history with technical analysis reaches back more than 25 years when I started as a young intern at Prudential Securities. At that time, there were no software packages or data feeds to generate any type of technical analysis. Hell, I hadn’t even heard of the concept yet, and I had a pretty heavy math background.

At first, it was some of the most boring work I did. But it quickly turned into a passion that turns profits.

See, my mentor followed Ralph Acampora, the director of technical analysis at Prudential. This guy was a rock star. He’d get on Squawk Box with Larry Wachtel every morning and talk basic technicals. Larry talked fundamentals (P/E ratios, cash flow, valuations, etc.), but Ralph had the edge, even back then.

My mentor had me charting stock prices on pages of graph paper for hours on end so that we could follow our own moving averages. Soon, we were forecasting and making our own buy, hold, or sell decisions – creating an unbeatable edge for ourselves.

Twenty-five years ago, technical analysis was voodoo science. Today, it’s the best way to churn profits out of the market.

What used to take me hours to update and track now takes just seconds. Thanks to today’s technology, data is not only robust but easily accessible and affordable. The term “voodoo science” no longer applies – technical analysis has entered the mainstream and rightfully so. It’s now one of the simplest and most effective means for juicing a portfolio’s performance.

From day traders to long-term investors focused on retirement savings, technical analysis has turned into a valuable tool for everyone.

The Demise of Fundamental Analysis

The rise of technical analysis is partly due to the fall of its counterpart, fundamental analysis.

See, fundamental analysis is all about looking at things like revenue, cash flow, margins, and earnings in order to put a value on a stock. These numbers, while published, are always subject to change based on something other than the basic operations of a company.

For example, earnings per share – one of the most watched fundamental analysis data points – can change based on the number of shares that are outstanding for a company. “Financial engineering” has become a popular and effective means for a company or private equity firm to “maximize” their value, thereby distorting the stock’s true value.

Unreliable data isn’t the only issue with fundamental analysis. The second problem is timing.

Gone are the days when you simply bought and held a stock, then walked away with a wad of cash 20 years later. I recently found some physical stock certificates that my grandfather bought me back in the late 80s on AT&T, originally called “The American Telephone and Telegraph Company.”

Since then, the stock is up around 600%. But these days, you can see a return like that in just four to five years if you’re looking at a FAANG stock like Netflix.

My point? A fundamental analyst usually sits on the sidelines, watching Netflix run through the clouds. The fundamentals don’t make enough sense to buy the stock – the company doesn’t make money, and it’s always overvalued in terms of price-to-earnings ratio.

So here are the fundamental analysts, missing out on a ton of cash potential.

Meanwhile, the technical analysis crowd just needs a year or so of data to determine the market values of a company and whether or not it’s the right time to buy or sell. And while the fundamental analysts sit on the sidelines, the technical crowd is timing entry and exit points based on price patterns to pull in over 700% over a five-year period.

When to Use Technical Analysis

The answer here is so simple… always!

Another aspect of technical analysis’s flexibility is the fact that it works in every type of market. Bull, bear, trading range – everything.

Patterns in prices change, and the fact is technical analysis allows the nimble investor to adapt to all market conditions.

Over my decades in the business, I’ve seen multiple bull and bear markets. The one thing that has become clear through every market is that technicals work all of the time. It doesn’t matter where the market is going.

A trend is a trend. The market can go up, down, or sideways… technical analysis will find the stocks to buy or short in all of them.

Enter the Phrase, “the Trend Is Your Friend”

I told you that of over 75 technical indicators, you only need to look at one if you want to increase your profit potential. And that’s the 50-day moving average.

This indicator is the lifeblood of the technical analysis world. There is no other trendline that embodies the phrase “the trend is your friend” quite like the 50-day.

How do you calculate it? Simple. It’s literally the average of a stock’s closing price over the last 50 days. That’s it! You’ve likely been doing this type of math since you were in the sixth grade.

Remember calculating your grade point average? You’ve got this. Better yet, you don’t even have to calculate it thanks to the wonder of technology. Any charting tool you need is at your disposal, right there on your laptop or smartphone.

Below is a three-year daily chart of the S&P 500’s 50-day moving average…

Here’s the simple application…

Years ago, I performed a laborious (you won’t see me pulling $3 words like that often) study on the 50-day moving average of all of the S&P 500 stocks individually. I pulled apart the relationship of this trendline on each stock and found the following simple rule…

When a stock’s 50-day is rising, there is a 2:1 likelihood that the stock will move higher. Similarly, when the 50-day is trending lower, there’s a 2:1 chance the next day’s price will move lower.

This easy rule provides the backdrop for simplifying technical analysis. Now, onto the application…

You see, technical analysis isn’t just technical science. It’s also has a little hint of art to it…

How to Harness the Art and Science of the Markets

As I already pointed out, the simplest application of the 50-day moving average is to take your lead from its directional movement. Now, when I have my “quant” hat on, I’m measuring the slope of the trend as well.

That additional bit of data determines just how bullish or bearish I should be. It helps me decide if I should buy the stock or the option.

Take semiconductor company Nvidia Corp. (Nasdaq:NVDA), for example. It was a moonshot stock from 2016-2018, and it made most investors scratch their heads. The fundamental analysts sat on the sidelines for most of this run because the stock was extremely overvalued.

Through much of this rally, I watched the average analyst maintain a sell rating on the stock simply because its growth was unmaintainable.

As a technical analyst, I had a different view. The market was setting its value on the stock based on where the company was going, not where it had been. My favorite indicator, the 50-day, guided me to some mind-blowing profits with ease.

Notice that the 50-day helped avoid some serious declines in Nvidia’s precipitous fall in 2018 and 2019. Now, you didn’t miss the entire decline, but using the 50-day alone avoided a drop from $246 all the way down to $145 – almost half the stock’s value and a move that would have wiped out almost two years’ worth of gains.

The same trendline movement had you buying the stock near its 2019 bottom. And now, the most recent “signal” gave you an easy entry, buying the stock at $160 ahead of a run to $240. That’s a 50%-plus profit when the rest of the market returned around 13%!

Next, take a look at Tesla Inc. (Nasdaq:TSLA).

TSLA is volatile to say the least. Shares trade at multiples of the volatility of your average stock due to the constantly changing fundamentals. This, of course, makes the stock impossible to value using traditional fundamental measures. In other words, you’d be hard-pressed to ever trade TSLA unless you had another form of analysis… like technical analysis.

Once again, the simple application of the 50-day moving average identifies tradable trends that any investor could use to grab some serious gains.

Note in this example the addition of a yellow “neutral” reading. These occur when the stock’s volatility exceeds an acceptable level, in essence telling us that we should simply avoid the stock until things cool down.

So there you have it – technical analysis using the 50-day on two of the market’s most volatile stocks. But this indicator works for every stock – even nonvolatile ones.

Look at Procter & Gamble Co. (NYSE:PG). With a stock like this, fundamental analysis is effective – I’ll give you that. But the technicals will still generate better long-term investment results.

If you were using the 50-day moving average, you would have held this stock as a bull for almost all of the past three years. That “almost” comes into play during four short periods in which the stock saw declines when you would have sold your shares and then repurchased them at lower prices instead of simply holding through the decline.

For example, the 50-day trend indicator would have had you selling PG stock in February 2018 and then buying them back in July. During that time, the stock dropped about 14% – a drop that you would have avoided completely!

Now, note that the indicator doesn’t get you out at exact tops or back in at exact bottoms. Franky, we’re not trying to call exact moves, just moves large enough to make a big difference on your portfolio returns.

The Bottom Line

Simple to track and apply, the 50-day moving average trend is considered one of my “island indicators.” You know, one that I would choose if I were stranded on an island and could only have three to use!

Easy access and simple application makes it a low-effort, high-impact indicator that anyone can use to boost their portfolio returns – way above the level of most professional money managers.