Technical Analysis 101: Trends, Volume, Support and Resistance

People often ask me what do I look at first when I initially study a stock chart. The answer, in this specific order is, trend, support/resistance, moving averages and volume. Then, I begin to flip through time frames. So if I’m looking at a new stock for the first time I often begin with the daily chart, then I will zoom out to the weekly (usually 3 year) and sometimes the monthly. Occasionally I will zoom into hourly and even 5-minute charts if I am trading a stock on a shorter time frame, or I am concerned about my exact entry or exit price.

To understand technical analysis from the ground up, perhaps it’s best to start constructing a chart from the ground up. We begin with a solid line chart of TSLA (Tesla Inc) since its IPO inception in 2010:

This is a no frills chart that excellently, and simply, represents one thing: price. TSLA shares began trading publicly (on the Nasdaq stock exchange) on June 28th, 2010 at $17/share and recently (June) traded as high as $386.99 for a 7-year gain of more than 2100%.

When seeing a strong uptrend, technicians often describe the chart as moving from the ‘lower left’ to the ‘upper right’ of the chart. Such is the case with the above TSLA chart.

Next, we will add volume to the chart:

Notice that volume (in this case each volume bar represents the total number of shares traded that particular week) in TSLA shares expanded tremendously in 2013 as the share price broke out to the upside and went on a tear that would see the share price reach nearly $200 in September 2013. The strongest bullish breakouts (powerful upside price moves, usually to new highs) occur with an expansion of volume. The 2013 breakout in TSLA (above ~$40) could be put in a textbook under “Upside breakout volume profile.”

Next, we will add a simple moving average to help better illustrate trends:

The blue line is the 50 period simple moving average (SMA), and in this case it’s the 50-week simple moving average. A simple (as opposed to exponential) moving average is simply “a succession of averages derived from successive segments (typically of constant size and overlapping) of a series of values.” (Google)

A moving average is a trend-following indicator that can help us to more clearly identify trends. For example, in the above chart during most of 2013 and 2014, TSLA’s 50-week moving average had a steep upward slope indicating the stock was in a strong uptrend. The 50-week SMA then flattened at the beginning of 2015 and remained fairly flat until the beginning of 2017. This flattening indicated a period of oscillation in TSLA shares, in which there was no clear trend. Then in 2017, the 50-week SMA turned upward again as TSLA shares broke higher and nearly reached $400/share.

The final topic I would like to touch upon in this piece is basic support/resistance analysis. Let’s have another look at our TSLA chart above; can you identify clear levels of resistance (price levels at which demand wanes and sellers move back into control i.e. price peaks) and support (price levels at which demand increases and supply of shares dries up i.e. price bottoms)?

In this basic line chart we can easily see that the $280 level was resistance for nearly three years, as price could not close above this level. In fact, there is a fairly standard ‘double-top’ in the above chart after price to sustain itself above $280 for the second time in July 2015.

We can also see that $180 appears to be a strong level of support for TSLA. First, it proved to be a resistance level in 2013 after TSLA shares had soared nearly 400% in the span of a few months, but then the $180 level became support (former resistance often becomes support) during declines in 2014, 2015, and finally at the end of 2016.

Finally, notice that when TSLA shares decisively broke out above $280 in April of this year, the momentum carried the shares higher by an additional $100+. The difference between the $280 resistance level and the $180 support level is also $100. But that’s a topic for another day….

In my next installment, in addition to enumerating what technical analysis is not meant to be (i.e. crystal ball forecasting), we will cover basic Japanese candlestick analysis, basic chart pattern analysis, and delve into the question “what is technical analysis?”

 

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