3 Technical Tools To Improve Your Trading
Technical analysis is the study of stock prices and pricing patterns that can help investors determine whether a stock is overbought (expensive) or oversold (cheap). By using various technical indicators together, called correlation, traders can bring the "big picture" about a stock into clearer focus.
Here we'll look at volume, the Aroon indicator and Fibonacci numbers, three technical analysis tools that can be used to help facilitate more profitable trades. In fact, investors can use them in conjunction with each other to spot emerging trends and stay ahead of the crowd. Read on to find out how.
Turn Up the Volume
Volume is defined as the number of shares that trade during a period of time such as an hour, a day, a week or a month. This shows the strength of an upward or downward price move. Generally, low volume occurs when prices move sideways or stay within a trading range, or during market bottoms. Conversely, high volume signals the beginning of a new trend (two or more high or low points) in the stock. High volume also occurs at market tops when there is strong conviction that prices will be moving higher, and can be used to confirm an upward or downward trend. If the stock is moving upward it should have higher volume on the upward moves and less volume on the downward side. Conversely, heavy volume on the downward moves and lower volume on the upward moves points to a downturn. By using volume in conjunction with movements in the stock you can spot the right areas to get into a trade. (For background reading, see Volume Oscillator Confirms Price Movements.)
Tune in to Aroon
The Aroon indicator can help pinpoint the strength of a trend and the chances that it will continue. Generally investors look for a move above or below zero (the no-trend, or neutral zone) to determine whether a new trend is emerging. A cross above zero indicates an upward trend (an "Aroon up"), while a cross below zero indicates a downward trend (an "Aroon down"). An indication near the zero line with no solid crossovers up or down indicates that the stock could continue to consolidate for a while until a direction is confirmed. The Aroon indicator can help uncover an emerging trend and enable you to take profits or protect yourself from losses. (Finding The Trend With Aroon explains how to use this tool in greater detail.)
Fibonacci numbers or studies are a series of numbers in which the following number is the sum of the two previous numbers, such as 1,1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 and 233. You can use these numbers in trading in conjunction with support (the price where the stock has stopped falling in the past) and resistance levels (the price where prices have stopped rising previously). (For background reading, see Taking The Magic Out Of Fibonacci Numbers.)
After a significant move up or down, the stock will usually retrace its movement by a certain percentage. During these movements, investors can use the Fibonacci number to see if a stock is going to touch a support or resistance level and bounce off. If it does, this signals that the stock is going to resume its original direction, either up or down. If the stock breaks that level, the investor looks to the next area of resistance or support to see if that is the point where the stock will resume its original move. (To learn more, read Retracement Or Reversal: Know The Difference.)
As general rule, Fibonacci numbers should be used in conjunction with support and resistance levels to confirm whether the stock has bottomed out or stopped rising at these points.
Putting It All Together
Using volume, Aroon and Fibonacci indicators together can help investors pinpoint whether a stock is likely to move up or down. Volume signals enthusiasm or fear, and whether the stock will continue to move higher, trend lower, top out or hit bottom. The Aroon indicator shows whether a stock is beginning a new trend or staying in a trading range, while the Fibonacci number will signal whether the stock has hit areas of strong support or resistance. While no one indicator is more important than the other, using the combination of all three can provide clues about a stock's overall directions.