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A BRIEF OVERVIEW OF BASIC CHART ANALYSIS & ITS ADVANTAGE OVER FUNDAMENTAL ANALYSIS
*Fundamental Analysis-Citibank-A Company With A Great P/E Went On To Fall More Than 95% From 2007-2009. Berkshire Hathaway Focusing On Fundamental Analysis Fell More Than 50% Twice From 1998-2009
*Benefit Of Using Technical Analysis, Price Action in Assisting Trading Decisions
*Very Important To Note Difference Between Trending Markets & Range Bound Markets & How Moving Averages & Bollinger Bands Should Be Used in These Different Types of Markets
FUNDAMENTAL ANALYSIS-HOW CITIGROUP WHICH HAD AN EXCELLENT P/E RATIO IN 2006 FELL MORE THAN 95% THROUGH 2009 & HOW BERKSHIRE HATHAWAY FELL MORE THAN 50% TWICE 1st FROM 1998-2000 & AGAIN FROM DECEMBER 2007-MARCH 2009
Twice today I spoke with friends interested in learning about "Investing". Both friends were quite intelligent but their line of questioning indicated major warning signals in their approach to stock selection & trading decision making. Both friends focused on fundamental analysis including Gross Domestic Product Numbers (GDP) released this morning & Price to Earnings Ratios (P/E). While most investors pay some attention to these statistics, in the past 30 years there has been a realization that Stocks with excellent P/Es can fall dramatically & that positive Economic figures such as GDP numbers can still be met with selling. Citibank (Quote=C) had an excellent P/E ratio as recently 2006 before falling more than 95%. Arguably one of the best Fundamental Investors of all time, Warren Buffett proves the intermediate shortfalls of not heeding warning signals from moving averages. Focusing on Fundamental analysis, Berkshire Hathaway fell From June 1998 through March 2000 more than 50%. After rising for many years thereafter, Berkshire once again proved the problem of not heeding warnings from technical analysis from December 2007 through March 2009 when Berkshire fell more than 55%
TECHNICAL ANALYSIS-BENEFITS OF USING PRICE ACTION TO GUIDE BUY & SELL SIGNALS & HOW MOVING AVERAGES & BOLLINGER BANDS ASSIST TRADERS IN DETERMINGIN BUY & SELL SIGNALS & THE DIFFERENCE BETWEEN "TRENDING MARKETS" & "RANGE BOUND MARKETS"
Justin Mamis in his books "When To Sell" & "How To Buy" notes that price reaction to economic news or earnings data is far more revealing than the data itself. If a company comes out with seemingly amazing earnings but drops 10% in after hours trading it is likely that traders focusedon another piece of data. Alternatively, if appealingly less than stellar GDP numbers are released & yet the market rallies it is likely that their are underlying strengths that are serving as a base for the market.
It is very important to note that markets their are major differences in using moving averages & Bollinger Bands in markets that are trending versus markets that are range bound.
Range Bound: moving sideways between levels of lower resistance & upper support use moving averages to assist in interpreting important levels within the range.
Trending Markets: or rising consistently with pullbacks to rising levels of support use moving averages & Bollinger Bands to help guide possible purchase levels & a method to confirm or invalidate trends.
Chart Analysis assists traders in focusing on arguably the most important piece of data to traders, price action. A stock or other asset that is able to rise above it's 200 day movingaverage (average closing price of the stock for the past 200 trading days) it is a sign of strength & upward price momentum in the stock. If an asset falls below the 200 day moving average, it is a sign that their are problems being revealed in price action. A very simple rule of thumb some passive traders use is buying assets as they cross above their 200 day moving average & selling assets as they cross below their 200 day moving average. A closer analysis of charts would implement other key moving averages including the 21 day, 50 day & 100 day moving averages amongst others. Moving averages act as support for assets as they fall & they act as resistance as assets rise.
Even further analysis may include Bollinger Bands which can be used to measure both 1) assets that are "overbought" or "oversold" or 2) an asset that has begun a new trend. In "range bound" markets i.e. trading between a defined up level & low level Bollinger Bands can provide 1 factor used in determining overbought or oversold levels. If a market is "trending" i.e. rising steadily or falling steadily, Bollinger Bands can be used to both confirm the trending nature of the asset & measure projected price targets consistent with the trend in place. There are many many more ways to interpretprice action but Moving Averages & Bollinger Bands are two widely used basic measures traders can use to help identify possible price targets favorable for buying & selling stocks, commodities or currencies.
P/E RATIOS, ECONOMIC NEWS & ALL FUNDAMENTAL ANALYSIS WILL BE REFLECTED IN PRICE ACTION-CHARTS WILL REVEAL THE MOST IMPORTANT INFORMATION
The cumulative information from P/E ratios, GDP figures etc. will be reflected in price action. Using charts to read past headline economic & earnings materials is an excellent way to interpret successful buy & sell signals. It is important to note that chart analysis is only 1 part of successful investing. Learning to use these pieces of information along with proper risk managment techniques including the consistent implementation of stop-loss orders or protective options as a hedge are all vital steps towards investing success.
For a further use of moving averages including analyzing an asset using moving average bands which take average daily highs & average daily lows thereby forming a band giving buy & sell signals. The "moving average bands" analysis was doene by Sandy Jadeja from ODLSecurities who is a regular Technical Analysis contributor at CNBC Europe.
© 2009 CNBC, Inc. All Rights Reserved.
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