If you’re one of those people who invests your money in to stocks and bonds for the long term, good for you. For the large majority of retail investors it’s not only the best way to make money, it’s the only way. As they say, there is a fine line between investing and gambling in the markets and for those who attempt to trade the markets, many are doing nothing more than gambling.
First, let’s define trading. Trading is a short or medium term investment in a financial product. Traders have no intention of holding an investment for a long period time and the short term and day traders may hold a stock (or other product) for as little as a few minutes.
The sophisticated traders don’t consider their craft to be gambling because they often employ very sophisticated tools that help them make educated choices about the products they will trade.
One of the main tools traders use is technical analysis which, generally speaking, is chart reading. There are other, more complicated facets to technical analysis but a chart is still the most commonly used tool. Let’s take a look at the basics of chart reading and what you should know to get started.
This is a chart of everybody’s favorite stock, Apple. You can see four main parts to this chart. First, the jagged line is the price action of Apple since October 2011. It doesn’t take a chart reading genius to see that Apple has performed well since the end of November of 2011. If you look at the overall trend, you can see that Apple has had a big run to the upside with some minor corrections along the way. Although exciting to see, traders often get nervous when the see a chart like this because large moves to the upside can only sustain themselves for so long.
Also in this chart there are three colored lines representing the 20, 50, and 200 day moving averages. You can read about moving averages here  but just as we learned to average numbers in grade school, moving averages do the same thing but each day a new number is added and the first number is taken away. A 20 day moving average averages the last 20 days and the 50 day averages the past 50.
The three most common moving averages, the 20, 50, and 200 hold a lot of significance among technical analysts. Looking at the Apple chart above, we can see that Apple hasn’t dipped below its 20 day moving average since it started the recent uptrend and when it has touch the line, it immediately bounces back up.
This means that the 20 day moving average is currently acting as support. Providing it stays above its support, traders generally feel ok about holding on to the stock. If it dips below the 20 day, they may sell and repurchase the stock if it trades down to the next big support line, the 50 day moving average. It’s also important to note that some stocks are more attached to the 50 day moving average while others don’t seem to respond to these trend lines at all.
This is just one example of how the moving average is used as technical analysis tools by traders. When a stock breaks through a support line, traders often sell but if it reaches one of these trend lines and breaks through to the upside, that is often seen as a reason to buy.
More to Come
If you’re thinking that it must be a lot more complicated than this, you’re right but the moving averages don’t get a lot more complicated than watching how a stock reacts when it reaches one of these moving averages. Traders often set automated stops at these trend lines which is what make them so powerful.
Next, we’re going to look at some patterns in the actual stock’s price action. The jagged line that represents the historic price data of the stock can tell us a lot about its future movements although remember, long term investing that doesn’t take in to account market timing is still the most profitable way to invest your money.