Technical Analysis Explained

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There are two kinds of participants in the market: Fundamentalists and Technicians. Fundamentalists call themselves as value investors, based on the belief that they can calculate the intrinsic value of a stock. If a stock goes out of favor, meaning the stock price falls below its intrinsic value (under-valued), they would buy it and hold it until the price returns to its normal value and then sell it for a profit. Probably the most famous value investor is Warren Buffutt.

The other school of thoughts is the technical investing. Technical investors believe that nobody knows the intrinsic value of a particular stock, stock price is often driven by fear, greed, news and rumors. On the other hand, they believe that any news and rumors will show up on the chart as price actions. So instead of pains-takingly look for a magic formula to explain why people buy one stock and sell the other, they just focus their attention on the chart, so they call themselves as chart-readers or technicians. They look for supports and resistances, try to determine if the stock is in the up- or down-trend and try to evaluate if a stock is over-sold or over-bought. Their investment decision is based on buy the over-sold and sell the over-bought.

While the chart reading can be a daunting job, but there are some technical indicators based on mathematical formula and equations gaining popularity recently. One of them is RSI - Relative Strength Index, which is briefly explained below:

A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine conditions of an asset. It is calculated using the following formula:



As you can see from the chart below, the RSI ranges from 0 to 100. An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued.



Successful investors usually look at both fundamentals and technicals in order to identify their ideal stocks.

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