You MUST Understand This Before Trading Stocks

If you want to trade stocks you MUST understand technical analysis.

It’s an investment style that focuses on price patterns to predict what the stock market will do in the next few minutes, hours, days, weeks, or even months.

Here’s everything you need to know about it:

How it works

Technical analysis focuses on 2 key metrics:

• Price

• Volume

The idea is that previous price movements create trends that will translate into future price movements.

In other words, how a stock moves in the recent past will determine how a stock will move in the new future.

What’s Newton's 1st law of motion again? An object in motion stays in motion?

Same idea, but with stocks.

How it helps

You can use technical analysis as a stand-alone investment style or in conjunction with fundamental analysis.

Fundamental analysis will tell you if a stock is overvalued or undervalued.

Technical analysis will tell you when to enter or exit your position.

Combining both provides a complete picture of a stock and how to invest in it.

The types of technical analysis

There are 2 main ways of understanding technical analysis:

• Chart patterns

• Technical indicators

Chart patterns focus on trends and appearances that occur when you track a stock’s price movement.

Some common chart patterns to take note of are:

• Head and shoulders

• Double top

• Double bottom

• Cup and handle

• Rounding bottom

• Wedge

• Pennant

• Symmetrical triangle

• Ascending triangle

• Descending triangle

Lucky for you, I already wrote a Twitter Thread covering each of those patterns.

Check it out here:

Technical indicators use formulas to analyze stock market data.

Some common technical indicators are:

• Relative Strength Index (RSI): Measures the speed of price changes

• Money Flow Index (MFI): Measures how money flows in and out of a stock

• Bollinger Bands: Measures a stock’s volatility

• Moving Average: Connects average prices over time

• MACD: Measures the difference between 2 moving averages

Risks to look out for

There are 3 main risks every trader is exposed to:

1. Data mining: When you trying to identify patterns in data that are insignificant

2. Overfitting: When you’re trying to identify patterns that aren’t present

3. Confirmation bias: When you search for information that confirms your beliefs and ignore information that disproves them

How to mitigate risks

If you use technical analysis the right way, you mitigate each of the 3 risks discussed above.

Here’s how to use technical analysis the right way:

• Use stop losses

• Use multiple indicators

• Backtest your strategies

• Have strict risk management

• Identify short and long-term trends

• Combine technical analysis with fundamental analysis

If you implement each of these risk management strategies you will fare better than 90% of traders.