Devoted to understanding the basics and fundamentals of investing

A Few Technical Analysis Principles:
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I am really reluctant to start down this path, because it can lead to some VERY convoluted and confusing trading practices, especially to those who do not put much stock in its regular practice. But technical analysis can also be lots of fun to learn about, sometimes.

Technical analysis can be compared to putting a puzzle together. Each piece of technical information represents a piece of the puzzle. One piece of technical information which could be of trading value might be whether or not an oscillator is overbought or oversold.

Another "piece of the puzzle" might be the most recent price's location within a trend channel. If all the pieces of the puzzle are put together in the right way, you should be able to decide whether or not to make an informed trading transaction, and which position to take.

When you are fitting the pieces together to obtain the total picture, you want as many INDEPENDENT pieces of information as possible. Often, all of the different oscillators (stochastic, formula X, RSI, CCI, etc.) will move together if they are turned to represent the same cycle. In other words, they move in very much the same way and don't really represent truly independent information. Often, it doesn't do much good to use RSI to confirm a formula X buy signal, for example. Even envelope analysis doesn't help sometimes, because when most oscillators are oversold, prices are usually touching the bottoms of properly constructed envelopes.

One source of truly independent technical information is the monitoring of support and resistance price levels. A support price level is a value where prices stop going down (often mercifully), turn around, and go back up. A resistance price level is a value where prices stop rising, turn around, and then drop (sometimes percipitously). There are several ways to ascertain price levels of support and resistance. I'll take on two of them right now.

One way to determine a support or resistance price level is to use frequently experienced retracement levels. Here is an example, taken from my own personal historic notebook: Suppose that the OEX index has been dropping but turns back up when it reaches a low of 415.00. Then, it rises to 425.00, turns around at that high point, and starts to drop again. It would not be unusual for it to drop back halfway to the previous low at 415.00 (at the level of 420.00) and then turn back up. In other words, it retraces 50% of the previous rise in prices before it resumes its upward trend. It is just amazing how often prices will retrace 50% of their last move, and this technique also works for rallies to resistance levels in a falling market. Other retracement levels that are frequently experienced are 61.8% and 38.2%. These are Fibonacci ratios which are usually rounded off to 62% and 38% respectively. This technique works for daily bar charts also; as a matter of fact, the technique works for charts with bars representing any period of time. The technique is especially useful for day trading with 5 minute, 15 minute, etc. bars. The most frequent retracement level is 50%. Deeper retracements are good early warnings that the main trend is about to turn.

Another technique for finding support and resistance levels is to locate price points that have been important turning points in the past. Often a previous resistance level becomes a current support level. Frequently, moving to a resistance level is accompanied by an overbought condition. Moving to a support level is frequently accompanied by an oversold condition. Often divergences between prices and formula X are experienced at these turning points ("chart points"). Try adding support and resistance level analysis to your other arsenal of technical tools. It's just amazing how consistently well this simple little thing works.

I suppose I could ultimately get after some other helpful technical analysis principles, if Larry decides to expand discussion of this subject, but I would greatly welcome some feedback and additional contribution from others out there who use (or have used) technical analysis as a basis for making their trading decisions. One-sided discussions can get pretty frustrating in a hurry...

Larry, on another subject which is still related to the primary purpose of this blog, I would be interested in your comments about whether or not refinancing is worth it? Using the old 2% rule, or is such a decision better made by analyzing how long you plan to continue owning the house and making the payments on a new loan? How influenced should I be by being offered a low rate with high points? Fixed or variable? How often are variable rate mortgages adjusted, and how high can they go? Do lenders sell the variable rate mortage harder than they do the fixed rate cousin because it is a safer loan for them to make? The idea of saving an extra two percent in interest is very seductive, especially when you have to fight for every eighth of a point on a fixed rate loan! What if, instead of lowering your payments on a refinancing, you increase the amount you borrow to fold in the payment of all your closing costs, and your payments stay the same? What if I refinance my home to improve my cash flow and lower my interest rate? What if I refinance to raise cash to live on or to buy another property (pyramid)? It has always seemed much easier for me to borrow money than it is for me to pay it back!