subject: Using Technical Analysis To Determine Stock Picks [print this page] Stock traders state that you can predict the expected movement of stock prices by the use of technical analytic tools. They feel that there are patterns developed within the stock prices, and that history will repeat itself. Three of these technical analytic tools are the directional movement index (DMI), the relative strength index (RSI), and the Williams %R.
The DMI has three components to it. The positive DMI indicates an upward trend. The negative DMI indicates a downward trend and then there is an average indicator. When the positive component is dominant, it is an indicaton that the market will continue upward. The opposite is true when the negative component is dominant. When this occurs the downward trend is expected to continue. When these two components cross over one another, a change in trend is expected.
The RSI analyzes the magnitude of stock gains and losses over a period of time. The formula can be quite complex, but basically the index will look back over the past 28 or 14 periods of time. By dividing the average gain with the average loss, you arrive at the RSI for the period of time being analyzed. The rule of thumb is that when the RSI is high, around the 70's, then the stock is overbought and is expected to drop. When it is low, around the 20's, then the stock is oversold and is expected to climb. If it is around the 40 - 50 range, then the stock price is neutral.
The Williams %R will look at the close of the day in relation to the high price and the low price for the past number of days. This index is used to indicate if a stock is overbought or oversold. It is very similar to the RSI, except it's reading is opposite of the RSI. If the index is at the zero or -20, then it is considered overbought. If it is near the -80 to -100, then it is considered oversold.
As you analyze different stock prices and review these three indexes, you can see some patterns develop that looks very similar to what is described above. A good piece of advice is to review other financial and technical analytic tools to confirm what you are seeing on the indexes. A review of the headlines is also an important thing to consider. I recently found a stock that had a straight line trend line. I was amazed at its trend line and was ready to perform an investment action. I then noticed that the company had a tendered purchase offer. That is why the stock price was straight lined. That company was soon going to be bought by another company. It is a good thing I checked the headlines.
