You Asked, I Replied – How To Use Technical Analysis To Enter And Exit A Trade
I'll start this year by answering an e-mail question from Leo. But instead of replying to his e-mail, I decided to put it into a post as the information I'm about to share is a core foundation that every investor or trader should know.
This post will tackle the basic concept on idea generation. How to find a good stock to trade and how to enter and exit without too much technical paralysis.
Happy New Year!
It's me again.
I've been studying and using value investing and fundamental analysis for quite some time now and I'm quite curious about "using technical analysis as a basis for the entry and exit point for stocks".
Though I haven't found any resources to read/watch to fully understand how it works. Any insight and advice would be much appreciated.
And BTW, your site has been really helpful for me and I want to thank you for that.
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How Fundamentals Drive Expectations And Sentiments
I'm always happy to help! So this year, let's start with this sentence and I want you and all that's reading this post to tweet this now...
"The Fundamentals of a company drive expectations and sentiments at any given time in the long-term."
This is the reason why you see uptrends, downtrends and sideways movements in the market. If the fundamentals are bad, there will be negative expectations which will give birth to negative sentiments. The result will be a downtrend market... and vice versa.
Now, using a bit of technical analysis enables you to enter at price levels where the market thinks it's undervalued.
For example, let's just say stock ABC is currently trading at 100 pesos/share. Then later on, the CEO of ABC company announced in a press release that the company will acquire new assets and businesses of company XYZ. The CEO also said that these acquisitions will boost the earnings and meet this year's target net income of 10 Billion pesos.
This is how the market works; What the CEO just announced is a fundamental driver of growth and this in turn translates to an 'expectation' in the market that the company will be able to increase its earnings within the year.
So now, investors have a valid reason to expect an increase in earnings.
What will happen next is that investors will now start to buy the stock in anticipation of the earnings growth because they now believe that the stock is 'cheap' relative to this. This is what we call a 'positive sentiment'. This will reflect in the charts on the coming months as an upward rally. In our example, stock ABC may rally to 150 pesos/share based on this.
Once the annual report is released, there are 3 things that may happen;
Putting Technical Analysis Into Action
Now, how do you use technical analysis in this?
Simple. By buying on retracements and key support levels and selling on resistance levels.
How hard it can be?
The way I do this is by using Fibonacci Retracements, Fibonacci Extensions and Pivot Points.
For example, if a stock is rallying, I will wait for a pullback on the 38.2, 50.0 and 61.8 retracement levels.
I'll buy on those levels because these levels are what the market perceives to be undervalued levels during the rally.
I'll take profit on the 100, 138.2 or 161.8 extension levels
Another strategy is to buy the monthly and weekly pivot support levels and sell on pivot resistance levels. You can also add positions on the retracements along the way.
I don't trade based on pure technical analysis. Pure technical analysis is gambling to me. Also, I no longer base my investing ideas on pure fundamental analysis.
I'm like 80% fundamentals, 20% technicals.
To guide you, here's a simple step-by-step process on how to find trading ideas.
If the price is trading below the intrinsic value, then this is much better and I consider the trade idea as a no brainer.
The best way to trade the stock market is to stay as logical as possible.
No fancy indicators, no moving averages, no candlestick chart patterns.
In short, NO CHART CLUTTER.
Just plain price levels and pure understanding of why the market is moving up or down will help you avoid the dreaded 'analysis-paralysis'.
Have any thoughts and questions? Feel free to post them in the comments sections below.