In our earlier guides, we looked at what to buy with fundamental analysis and at how much to risk on a trade. This guide covers the third question many investors ask: when? That is where technical analysis comes in.
Technical analysis is the study of price and trading volume on a chart. Instead of asking what a company is worth, it asks how buyers and sellers are actually behaving. Many investors combine the two approaches: fundamental analysis to decide what to buy, and technical analysis to judge when.
The three ideas behind technical analysis
Technical analysts usually start from three assumptions:
- The price reflects available information. News, earnings and expectations show up in what buyers and sellers are willing to pay.
- Prices tend to move in trends. Day-to-day moves can look random, but a trend that has formed is considered more likely to continue than to reverse.
- History tends to repeat. People react to fear and greed in similar ways, so patterns seen in the past can give context for today.
None of these is a law. Technical analysis is often described as "more of an art than a science," and it works with probabilities, not certainties.
How to read a candlestick chart
Many traders use candlestick charts. Each candle shows four prices for one period, for example one day:
- Open: the first price of the period.
- Close: the last price of the period.
- High and low: the highest and lowest prices, shown by the thin lines (wicks) above and below the candle.
When the close is above the open, the candle is usually green (or white). When the close is below the open, it is usually red (or black). A long green body means buyers were in control for most of the period. A long upper wick means the price went up but was pushed back down before the close.
The same stock can look very different on different timeframes. A daily chart can be in an uptrend while a weekly chart is still pointing down. That is why many experienced traders work from the top down: they first read the bigger picture on a higher timeframe, such as the daily or 4-hour chart, and then look at a 15-minute or 5-minute chart to time an entry more precisely. Shorter charts show more detail, but they also show more noise and more false signals.
Trends: up, down and sideways
A trend is the general direction of the price:
| Trend | What the chart shows |
|---|---|
| Uptrend | Each high and each low is higher than the one before |
| Downtrend | Each high and each low is lower than the one before |
| Sideways (range) | The price moves between a ceiling and a floor |
A trendline connects two or more of these points. In an uptrend, the line is drawn under the rising lows. When the price breaks below that line, technical analysts treat it as a warning that the trend may be changing, and they look for confirmation from other signals before drawing conclusions.
Fidelity's education material describes three timeframes for trends: long-term (a year or more), intermediate (one to three months) and short-term (less than a month).
To see trends across many stocks at once, the L.WIN stock screener scans about 200 large US stocks plus your watchlist. For each stock, it shows the performance over the year (or 52 weeks), 6 months, 3 months and 5 days, and how far the price is from its 52-week high. One click opens the stock's chart on TradingView.
Support and resistance
These are the two terms you will hear most often.
- Support is a price level where demand has been strong enough to stop a decline. As the price falls toward it, buyers become more willing to buy and sellers less willing to sell.
- Resistance is a price level where supply has been strong enough to stop a rise. As the price climbs toward it, more holders decide to sell.
Why do these levels form? Part of the answer is memory. Investors who missed a stock at $50 may plan to buy if it returns to $50. Investors who bought at $80 and watched it fall may sell when the price gets back to $80, just to break even.
A useful principle is role reversal: when the price breaks clearly above resistance, that level often acts as support later, and the other way around.
This is also how support connects to risk management. Many traders place their stop-loss just below a support level, because if the price breaks it, the reason for the trade may no longer hold. Our free Risk/Reward Calculator shows what that stop means for the trade, and the Position Size Calculator turns it into a number of shares.
Moving averages
A moving average smooths the price over a set number of periods, so the trend is easier to see.
- A simple moving average (SMA) gives every day the same weight.
- An exponential moving average (EMA) gives more weight to recent prices, so it reacts faster.
The 50-day and 200-day averages are among the most widely watched. When the 50-day average crosses above the 200-day average, traders call it a golden cross. When it crosses below, they call it a death cross.
Keep one thing in mind: moving averages are built from past prices, so they always lag. A crossover is a signal that many people watch, not an instruction to buy or sell.
Volume
Volume is the number of shares traded. Many technical analysts use it as a way to check how much conviction is behind a move. A price breaking above resistance on much higher volume than usual is generally seen as more meaningful than the same move on light volume.
RSI: a momentum indicator
The Relative Strength Index (RSI), developed by J. Welles Wilder, measures the speed and size of recent price moves on a scale from 0 to 100. It is most often calculated over 14 periods.
- Readings above 70 are traditionally considered "overbought".
- Readings below 30 are traditionally considered "oversold".
These words are easy to misread. "Overbought" does not mean the price must fall. In a strong trend, the RSI can stay above 70 or below 30 for a long time. That is why experienced traders rarely use the RSI on its own.
RSI divergence
Many traders also watch for divergence, when the price and the RSI move in different directions:
- Bearish divergence: the price makes a higher high, but the RSI makes a lower high. Traders read this as a sign that upward momentum is weakening.
- Bullish divergence: the price makes a lower low, but the RSI makes a higher low. Traders read this as a sign that selling pressure is fading.
A divergence is a warning, not a timing signal. In a strong trend, it can last a long time before the price turns, and sometimes the price does not turn at all.
L.WIN's AI reports include a 4-hour TradingView chart with the 200-period EMA and the 14-period RSI, so you can see the news and the chart in one place.
The limits of technical analysis
Technical analysis is popular, but it has real limits:
- It looks backward. Charts show what has happened, not what will happen.
- Signals can be false. A price can break above resistance and fall back the next day.
- Indicators can disagree. One may point up while another points down.
- A chart says nothing about valuation. A stock can be in a strong uptrend while its price-to-earnings (P/E) ratio is far above its own history or its industry. Experienced investors often check valuation as well, as we explained in our fundamental analysis guide. The L.WIN stock screener shows each stock's P/E next to its performance and lets you set a minimum and maximum P/E.
- News can override the chart. An earnings report or a sudden headline can move a stock straight through any level. That is why L.WIN flags stocks on your watchlist with earnings in the next 7 days.
For these reasons, many investors use technical analysis together with fundamental analysis and a clear risk plan, not as the only reason to make a decision.
A simple checklist before reading a chart
Experienced traders often go through questions like these:
- What is the trend on the higher timeframe, and does the shorter chart used for the entry agree?
- Where are the nearest support and resistance levels?
- Is the price above or below its 50-day and 200-day moving averages?
- Is volume confirming the latest move?
- Does the RSI confirm the price, or is there a divergence?
- Does the valuation, such as the P/E ratio, look stretched?
- Is there news or an earnings date that could change the picture?
- If the trade goes wrong, where would the exit be, and how much would it cost?
Key takeaways
- Technical analysis studies price and volume to understand how buyers and sellers are behaving.
- Trends are defined by higher or lower highs and lows. Trendlines help to see them.
- Support and resistance are price levels where demand or supply has stopped the price before.
- Moving averages show the trend but always lag. The RSI measures momentum, can stay extreme for a long time, and a divergence from the price is a warning, not a guarantee.
- No indicator is a guarantee. Many traders combine charts with fundamentals, news and risk management.
In a future guide, we will look at how news moves stock prices. Until then, you can try the free L.WIN tools.
This article is for educational purposes only and is not investment advice. Technical analysis does not predict future prices, and past performance does not guarantee future results. Always do your own research and consider your personal situation before making any investment decision.
Sources: Fidelity: What is technical analysis? · Fidelity: Basic concepts of trend · Fidelity: Support and resistance · Fidelity: Moving average stock signal · Fidelity: Relative Strength Index (RSI)