Technical analysis is based solely on price.
It shows you where buyers and sellers transacted in the past. It’s a visual representation of the supply and demand for a stock or ETF at different price points.
It doesn't predict the future. It shows us only what has happened.
Technical analysis is the collective actions, not opinions, of every market participant.
When people say it doesn’t work, they’re right. It doesn’t work — all of the time. But neither does any other form of analysis.
Technical analysis helps us:
- Find favorable Risk/Reward setups.
- A place to exit if we're wrong.
- And a place to take profits.
We break technical analysis into three factors:
- The Breakout Factor.
- The Retest Factor.
- The Support Factor.
The Breakout Factor
The breakout factor is triggered when a stock or ETF breaks out above a supply (resistance) level. Often, the stock or ETF is in an uptrend or has been trading in a range for an extended period.
- Over four-years, Lululemon tested the $82.50 level three times and finally broke above $82.50 in March 2018. The stock has gained 387% since breaking above $82.50.
Breakouts are my favorite technical factor. They tend to produce the largest gains in the shortest amount of time.
Think of it this way. A security trading in a range is building up energy for a big move one way or the other. The longer a security trades in a range, the larger the potential gain.
The Retest Factor
The Retest Factor is triggered when a stock or ETF retests a previous supply (resistance) level.
- After breaking above supply (resistance) at $89.10 (red arrow), UPS retested $89.10 several times from 2016 through 2020 (black arrows). And $89.10 held, until breaking to new highs in 2020.
The Support Factor
The Support Factor is triggered when a stock or ETF tests a previous demand (support) level. Often, but not always, the security is in a downtrend or has been trading in a range for an extended period.
- Price tested the demand (support) zone between $120-$140 (red arrows) until breaking to new highs in 2020 (green arrow).
The more times a demand (support) level is tested, the greater the chance it will break.
As we said at the start, no method of analysis works all the time, whether technical or fundamental.
In the end, superior investment results can only stem from a better than average ability to figure out when risk-taking will end in gain and when it will end in loss. There is no alternative.
Whether your ability comes from technical analysis, fundamental analysis, or a combination, do what works best for you.