A Beginner's Guide to Charting Financial Markets

03/01/2008 12:00 am EST

Focus:

Michael Kahn

Columnist, Barron's Online

A Beginner’s Guide to Charting Financial Markets: A Practical Introduction to Technical Analysis for Investors As a fundamental analyst, for years, the mere thought of technical analysis was enough to send me into a state of paralyzed fear.

In college, I was taught that it’s the company that counts—period. And in the first years of my career, I found great success in depending on a bottom-ups analysis to find very profitable stocks. But, as with any good analyst, I constantly sought methods to improve my results, and finally came to the conclusion that employing a select few technical indicators could help me better determine the timing of my purchases and sales.

Consequently, I was more than pleased to see this book cross my path.

Kahn is a technical analyst with a vast array of experience, and he has used that expertise to hone his technical skills to produce excellent results. Yet, like many good analysts, he also sees merit in using a repertoire of tools to excel—even when that means combining the schools of thought of both fundamental and technical analysis.

Fortunately, pure technical analysts, as well as fundamental analysts seeking to improve their results, will find a clear, concise understanding of basic charts and indicators in this book. It won’t turn you into a super-charged trader or technical analyst overnight, but it provides a good starting point to understanding the business of charts.

Kahn explains that the art of chart watching goes back 200 years to Japanese rice trading. Charles Dow was the forefather of modern technical analysis. But the industry really took off upon the arrivals of computers, when sophistication blossomed. That created an explosion of trading activity by individuals in the 1990s, which resulted in an incredibly liquid market—the perfect situation for trading.

He begins his introduction to charts by explaining that the stock market is simply the sum of the actions of everyone in it. And investors and traders can use charts to interpret the meaning of the market by plotting price action over time, from which they can see trends emerge and patterns form. Charts allow the user to quickly spot where the market may encounter problems or where it presents a good risk to take. And technical analysis is the only discipline that lets you know immediately when you are wrong so that you can minimize your losses.

By many graphical examples, Kahn takes the investor through examples of trends and patterns. He defines resistance and support, saying that resistance slows or stops a trend, while support holds the market from falling further, at least temporarily. Both are simply functions of supply and demand.

Kahn spends quite a bit of time pointing out that charts help you understand what drives the market, stating that it is perceived value, not value that rules the day. And charts help you determine how to interpret perceived value by the actions of the people in the market.

It all boils down to a simple question: do you want to be in the market, and if so, what should you buy? Technical analysis is a tool used to help you assess the risk and reward of each decision. From the charts, you can decide when a stock has reached a support or resistance level, if there has been a shift in perception, and whether you should buy low and sell high, buy high and sell higher or buy at all.

Kahn takes the reader through the various forms of market analysis, including fundamental, economic, quantitative, technical, behavioral, socionomic, random walk, and buy and hope. Then, he gets into the nitty-gritty, demonstrating by visuals, the basic parts of a chart and how to use them. He also defines and demonstrates via charts, how to use volume, momentum, structure, and sentiment indicators.

Here, techies will love the bars, overlays, indicators, and pattern shapes. But fundamentalists need not despair—I think that even the most chart-challenged analyst will find that he can learn a few tricks of the trade that will help him determine his optimal entry and exit points.

Lastly, he gives the reader a checklist for success, explaining what you want from each of these indicators.

He leaves the reader with one caution: technical analysis works best when there is a crowd to analyze—in other words, when there is sufficient liquidity in stocks. Therefore, he suggests that you restrict this type of analysis to stocks that trade at least 100,00 shares per day.

I found that it takes some practice to really begin to understand the charts and indicators. But for beginning technical analysts or for fundamentalists looking to improve their results, this little book will give you the basics from which you can build your technical skills.

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