Technical Analysis 101 with Stocks Down Under: Sentiment and Stop Losses

Why do we even use technical analysis? 

First off, we’d like to point out that we don’t use technical analysis just by itself. We use it in conjunction with fundamental analysis to come up with more accurate forecasts of stock price movements. 

 

 

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There is certain information contained in stock charts that we can decipher using technical analysis that otherwise would be neglected, i.e., if we just used fundamental analysis. This information is often crucial in determining the direction of stock price movements. 

Below we will explain some of the most important information we obtain from the technical analysis. 

 

Sentiment 

If you have any experience with financial markets, you probably have heard of “Bulls and Bears” or “Bullish Market or Bearish Market.”  What this terminology refers to is actually the sentiment on the market or on a particular stock or any individual financial asset.  

Bearish sentiment on a stock means market participants overall are pessimistic about the stock and this pessimism is likely to drive the stock price lower.  

On the other hand, Bullish sentiment on a stock means market participants overall are optimistic about the stock and, consequently, we can expect this optimism to continue to drive the stock price higher. 

There are certain technical analysis tools that allow us to read the sentiment on a stock. These tools include price trends, moving averages, price action and momentum indicators, such as MACD. We will introduce you to some of these tools in upcoming articles. 

Now imagine that you buy a stock based on fundamental analysis alone without paying any attention to the market’s bearish sentiment on the stock. What will happen in most cases is that the market keeps beating down the share price while you are thinking you’re holding a hidden gem that fools on the market are selling for cheap prices, whereas the only thing that is going up is losses in your account. 

 

What are Stop Loss and Take Profit levels? 

Whenever you open a position on a stock, whether long or short, it is important to have a plan that’s tells you what to do when the share price moves away from your entry level. If the share price moves in your favour, you’ll need to know a price level at which to a take profit before the price starts to reverse. This level is called a take profit level. 

On the other hand, if the share price moves against your position, you’ll need to know a price level at which to stop your losses to limit the damage to your account. This level is called a Stop Loss level. 

Technical analysis gives you more flexibility regarding risk management. You can use it to determine price levels below which you will sell your stock and stop your losses because if the stock price goes below those levels, from a technical analysis point of view, the chances of further declines will increase. 

Similarly, when the stock price moves in your favour, technical analysis will tell you at what levels there will likely be high profit-taking pressure, which may drive the share price lower. This insight will allow you to take profits at more attractive prices. 

 

Technical analysis helps you to track the smart money 

Technical analysis can sometimes signal coming news for a stock before the news is announced to the public. This is because there are always better-informed investors who can see things happening with a stock before the rest of the market does. Thus, they begin to act on their information and their buy or sell activity changes the stock chart. A technical analyst can read these signals on the charts and act before the news come out and a significant change to the share price occurs.

Smart money refers to the money that the more informed investors move in and out of stocks. 

 

This article was an introduction to a series of technical analysis lessons that we will publish in the future. Each article will be focused on one of the most widely used technical analysis tools and techniques that we also use in some of our articles. 

 

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