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Many investors analyze stocks based on their fundamentals – such as their revenue, valuation, or industry trends – but fundamental factors aren’t always reflected in the market price. Technical analysis helps traders and investors navigate the gap between intrinsic value and market price by leveraging techniques like statistical analysis and behavioral economics. Most investors use both technical and fundamental analysis to make decisions.

Choose the Right Approach

There are two different ways to approach technical analysis: The top-down approach and the bottom-up approach. Often times, short-term traders will take a top-down approach and long-term investors will take a bottom-up approach.

  • Top Down – The top-down approach involves screening for stocks that fit certain technical criteria. For example, a trader may be interested in stocks that broke out from their 50-day moving average as a buying opportunity.
  • Bottom Up – The bottom-up approach involves analyzing a stock that appears fundamentally-interesting for potential entry and exit points. For example, an investor may find an undervalued stock in a downtrend use technical analysis to identify a specific entry point when the stock could be bottoming out.

In addition to these considerations, different types of traders might prefer using different forms of technical analysis. Day traders might use simple trend lines and volume indicators to make decisions, while swing or position traders may prefer chart patterns and technical indicators. Traders developing automated algorithms may have entirely different requirements that use a combination of volume indicators and technical indicators to drive decision-making.

How to Get Started

There are five core steps to get started with technical analysis.

  1. Identify a technical analysis strategy or develop a trading system.
  2. Identify tradable securities that fit with the technical strategy.
  3. Find the right brokerage account for executing the trades.
  4. Select an interface to track and monitor trades.
  5. Identify any other applications that may be needed to implement the strategy.

Let’s go through each of these steps with an example.

Identify a technical analysis strategy or develop a trading system: The first step is to identify a strategy or develop a trading system. For example, a novice trader may decide to follow a moving average crossover strategy, where he or she will track two moving averages (50 day and 200 day) on a particular stock price movement. For this strategy, if the short-term 50-day moving average goes above the long-term 200-day moving average, it indicates an upward price trend and generates a buy signal. The opposite is true for a sell signal.

Identify tradable securities that fit with the technical strategy: Not all stocks or securities will fit with the above strategy, which is ideal for highly-liquid and volatile stocks instead of illiquid or stable stocks. Different stocks or contracts may also require different parameter choices – in this case, different day moving averages like a 15-day and 50-day moving average.

Find the right brokerage account for executing the trades: Get the right trading account that supports the selected type of security (e.g. common stock, penny stock, futures, options, etc.). It should offer the required functionality for tracking and monitoring the selected technical indicators, while keeping costs low to avoid eating into profits. For the above strategy, a basic account with moving averages on candlestick charts would work fine.

Select an interface to track and monitor trades: Traders may require different levels of functionality depending on their strategy. For example, day traders will require a margin account that provides access to Level II quotes and market maker visibility. But for our example above, a basic account may be preferable as a lower cost option.

Identify any other applications that may be needed to implement the strategy: There may be other features that are needed to maximize performance. Some traders may require mobile alerts or access to trade on-the-go, while others may leverage automated trading systems to execute trades on their behalf.

Traders should consider all of these and related questions to find the right fit for their trading needs while saving money on costs.

[There are many strategies and approaches to technical analysis that may be best for you. If you want to continue to learn more strategies and go beyond "getting started" Investopedia Academy's Technical Analysis Course is a great place to learn chart analysis and the essential indicators to turn a basic startegy into an actionable trading plan.]

Tips & Risk Factors

Trading can be a challenging career for anyone, which means that it’s important to do your homework beyond the above points. Some other key considerations include:

  • Understand the rationale and underlying logic behind technical analysis.
  • Backtest trading strategies to see how they would have performed in the past.
  • Practice trading in a demo account before committing real capital.
  • Be aware of the limitations of technical analysis to avoid costly failures and surprises.
  • Be thoughtful and flexible about the scalability and future requirements.
  • Try to evaluate the features of the trading account by requesting a free trial.
  • Start small in the beginning and expand as your build up experience.

The Bottom Line

Many investors leverage both fundamental and technical analysis when making investment decisions since technical analysis helps fill in the gaps of knowledge. By developing an understanding of technical analysis, traders and investors can improve their long-term risk-adjusted returns, but it’s important to understand and practice these techniques before committing real capital to avoid costly mistakes.

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