When looking at a graph showing the movement of a stock price, the numbers can seem a little strange. In business when we set a price for something that price doesn't change unless we consciously change it. In the stock market thou, price can change based on the whim of the people who are buying and selling at the time. A publicly traded company cannot come out and say "We feel that this company is worth $25/shr and we will not buy or sell any of the stock unless it is for this price." The price can change only between the buyer and seller based upon what they feel the stock is worth that moment. This is referred to as the psychology of trading and has some predictable characteristics.

Technical traders boil all of the various different real and psychological inputs and outputs into trends which they then use to determine whether to buy, sell, or hold a stock. There are numerous methods that are used to determine which way a stock is going to move. Some of it is straight science. Some of it is based on hunches. All of it is just another tool in the process of due diligence.

The October 4th, 6 month stock chart of Dell Computer Corporation will be used to illustrate 5 aspects of technical analysis: Moving Averages, MACD, Stochastic, Relative Strength and Trend Lines.

Simple Moving Averages (SMA) are among the most popular technical indicators. In the example we show a moving average of the last 10 and 20 days prices. When the SMA(10) rises above the SMA(20) it is a signal that the price for this stock is moving up and is a possible time to buy. Similarly when the SMA(10) falls below the SMA(20) is it a possible time to sell.

MACD stands for Moving Average Convergence /Divergence. It shows the relationship between two moving averages. The basic MACD trading rule is to sell when the MACD falls below its signal line (the line in blue) and to buy when the MACD rises above its signal line.

The Slow Stochastic oscillator is used to determine market reversals. It compares where a security's price has closed relative to its price range over a specific period of time. Readings above 80 are strong and could indicate that price is closing near its high. Readings below 20 are strong and could indicate that price is closing near its low.

The Relative Strength Index (RSI) is a momentum indicator which measures a security's price relative to itself and its past performance. The RSI ranges between 0 and 100. RSI is said to indicate an "overbought" condition when it is above 80 and an "oversold" condition when it is below 20.

The last item that needs to be covered is the use of trend lines. Trend lines are used to show when a segment on the graph is trending up, down, across or when a trend can be considered to the broken. When a segment is trending down, the trend line is drawn from the top of the data. When a segment is trending up, the trendline is drawn from the bottom of the data.

When these five indicators are combined with other due diligence, the result can be a greater understanding of which way a stock is going to move. That is not to say that an understanding of the technical direction a stock should go is any guarantee that a stock will, with 100% certainty, go in that direction. But it does improve the odds that your guesstimate will be more accurate. Playing the stock market still involves an element of risk.

Going back to the example, we can see that by combining each indicator the buying and selling points become obvious. Trend Line 1 (TR 1) shows the ending of downturn in the stock price around June 1st. The first indicator is the stochastic which reverses once the second line crosses the 20 threshold. The second indicator is the MACD which crosses the 9 day moving average. At this point we can clearly see the up trend in stock price and relative strength of the stock so that by the time the third buying signal is reached (the SMA(10) crossing the SMA(20)) we can be fairly confident we are in an up trending stock.

Similarly for the selling point, TL 3 shows us the end of an up trend followed by selling signals in the stochastic (15-Jul), MACD (20-Jul), and the moving averages (28-Jul). The Trend lines clearly show a declining stock and a fairly confident indication that it's time to sell.

Under a best case scenario, the return on investment for this transaction would have been 30% (Buy: $33 / Sell $43). Under a worst case scenario, the return on investment would have been 14% (Buy: $36 / Sell $41).

If you have been use to strictly using a fundamental approach to investment, then it should be obvious how even a rudimentary technical analysis such as this can help improve the profitability of your portfolio.

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