Here's the deal with charts: They are just a tool.
Charts visually represent the supply and demand for a stock at different price levels.
Charts don't predict the future. They only show what has happened.
Technical analysis is every market participant's collective actions, not opinions.
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 with three things:
- First, find favorable Reward/Risk setups.
- Second, a place to exit if we're wrong.
- And third, 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 when a stock breaks above a supply (resistance) level. Often, the stock 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 builds up energy for a big move one way or the other. Therefore, the longer a security trades in a range, the larger the potential gain or loss.
The Retest Factor
The Retest Factor is when a stock 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 when a stock tests a previous demand (support) level. Often, the stock is in a downtrend or has been trading in a range for an extended period.
- The 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 analysis method 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.