Technical Analysis Basics: It’s More Than a Chart

Technical Analysis is more than just searching for a chart. Where should I start? What are the basics? Do I need to be looking at certain charts at certain times? We’re going to dive into these topics in this episode. Managing Director at the CMT Association, Tyler Wood joins IBKR’s Senior Manager of SEO and Content, Cassidy Clement to discuss financial charts and technical analysis.

Contact Info:

TYLER WOOD, CMT

tyler@cmtassociation.org

Website: CMTAssociation.org

Co-Host of Fill the Gap

Summary – Cents of Security Ep. 14

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, senior manager of SEO and content at Interactive Brokers. Today, I’m your host for the podcast. Our guest today is Tyler Wood. He’s a chartered market technician and the managing director at the CMT Association. We’re going to discuss financial charts and technical analysis. There are so many charts out there, but many may ask, where should I start? What are the basics of technical analysis? Do I need to be looking at certain charts at certain times? With all these questions, we’re going to dive into those topics today. So, with that, welcome to the program, Tyler.

Tyler Wood

Thanks so much for having me, Cassidy. Great to be back.

Cassidy Clement

Awesome. So, I guess to kick off for our listeners on this channel, they may not have heard you on some of our other podcasts before. What is your background in the field of finance and technical analysis?

Tyler Wood

Absolutely. I started the way almost everyone does with a strict diet of fundamental values and investment criteria. I did my MBA, Master’s in Business Administration from the Kelley School of Business at Indiana University, and it was a great program, but it was all about corporate finance, managerial accounting, obviously, with the trajectory of wanting to manage a company. I got to New York and met some wonderful people. Ralph Acampora, who is the founder, co-founder of the CMT Association, along with Louise Yamada, Alan Shaw, Phil Roth. And they took a lot of their time and energy to help me understand how markets work, not how companies work, but how markets work. And all of them have a deep respect for the fundamentals of the companies that you invest in from an equity sense. But markets work differently, and you’re not buying the whole company. You’re buying shares of a company. And so understanding things like price behavior and sentiment are very important.

Cassidy Clement

So, as we move forward with our conversation about some of these financial charts and technical analysis, I just wanted to hit on some of the basic words we are going to be in this conversation and some of the jargon. So, I guess the first thing is maybe explain to our listeners the difference between an index and an individual equity, something like, you know, maybe the S&P 500 versus a stock. If you can give us some light on that.

Tyler Wood

Absolutely. So, from a technical analysis perspective, when you’re looking at a chart, it really doesn’t matter what the ticker symbol is, what the company is. The tools that we’re using to understand price behavior are the same. But for those who are listening, it’s very important to understand what you’re looking at on your chart. So, first things first. If you are looking at the stock market, that might be an index like the S&P 500 that you mentioned or the Russell Index, that’s 2000 securities, many more, well, let’s use the phrase small cap names. Larger companies exist within the S&P 500, and those indexes can be constructed in lots of different ways. So, you might want to look at just the the composition of all of the technology stocks. Well, the technology stocks in the S&P 500 can be looked at in the information technology index, and those are often represented by ETFs. So, the XLK is the ticker symbol for the information technology index of the S&P 500.

Cassidy Clement

So, then when we’re talking about some of these different assets, as you’re saying, within these indices or indexes or ETFs, some basic stocks, bonds and commodities.  Lightning round style: How would you explain these to our listeners?

Tyler Wood

So, I think the place to start for all the listeners is to recognize that anything that’s traded in a public market, meaning it’s not controlled by any one party, it’s a free publicly traded market and can be useful to look at technical analysis in your evaluation. So, that includes things like the oil market or orange juice futures, or if you want to look at currencies, you could look at the U.S. dollar against the great British pound or sterling. You could look at it against the yen from Japan. You could look at it against Korean won. And you’re going to see those relationships in the currency markets, in the commodities markets, as well as fixed income or bond markets. That’s just the debt side versus the equity side. And I’m sure you’ll have another podcast to talk all about the differences between owning equity shares versus owning debt. Interestingly, the fixed income market, you can buy debt that holds a corporation to task ,to pay you back, but you can also buy debt from governments. So, the US government offers Treasury bills and that debt can be traded just like any other security, like orange juice futures or the stock of Apple Company. Technical analysis, one of the beautiful parts of it, is that it’s universal. The tools are the same no matter what you are looking at.

Cassidy Clement

Something that you mentioned was fundamentals early on when you were talking about some of your education background. But fundamental analysis is usually another piece of this. So how does technical analysis differ from that?

Tyler Wood

So, we like to talk about technical analysis as the set of tools that helps investors navigate this big gap or chasm between intrinsic value and the market price. And what we mean by that is that on the fundamental analysis side, you would develop an estimate of what the intrinsic value of any share of a company might be. And fundamental analysts are going to look at things like cash flows and they’re going to look at the quality of those cash flows and the growth of those cash flows. They are also going to look at the balance sheet of the company and the management team and the products that are coming out that are going to generate those future cash flows and a lot of other metrics to understand what the company is worth. Now, analysts are going to have different estimates of what that company is worth. But let’s just say they decided Company X is worth $100 a share based on all of their models and looking at how much cash is in the bank and new products coming out. But the market is trading at $50 a share. So, the fundamental analyst is going to say that the company is undervalued, meaning their take on that stock is that it’s going to go up. Eventually the market price will move to their estimate of the intrinsic value of the company. So, they want to own that because it’s underpriced. As technical analysts, we believe that the market is always correctly priced because that’s what investors are willing to pay for shares of that company. So, from a technical lens, we can understand that gap between intrinsic value and market price, and then we could participate if it does indeed trend from that $50 up to $100. We have lots of tools to help us participate in those trends and get out when those trends end. But for the fundamental analyst, the starting point is that the market has mispriced the security. It’s undervalued, the market is wrong, and we believe that the market is the greatest fundamental analyst on the planet. And sometimes there are things happening inside of companies that we can’t possibly know about, but that the market starts to price into the shares of that company. There are a couple of really great examples, Cassidy, probably the listeners of this podcast are a little young to remember companies like Enron, but where there are scandals behind the scenes that often shows up in price before it shows up in all of the reporting that comes to fundamental analysts.

Cassidy Clement

Got it. So, for technical analysis, we’re kind of looking at charts or patterns within the stock or the asset where the fundamental analyst is more so looking at the financial pieces, maybe like you said, sales or stock value, things like that. So, the next question I’m guessing most people will have is, thanks for sharing this take with me, but can anyone do this, or do you need a formal training, because everyone looks at the stock market and says, ooh, pretty charts. They’re going up. They’re going down. Yeah, but that’s a lot of information when you pop the hood. So how would you explain some of the training or education or self-education of getting yourself to think like a technical analyst?

Tyler Wood

Great question. So, to understand, or to study the action of the market itself, you have to start with how you’re organizing your data. So, I will tell you that every financial news network on the planet is probably bringing some chartered market technicians onto their shows. Definitely pay attention to what those folks are sharing because they’re just interpreting what’s actually happening in the market. They’re not trying to forecast or tell you that they know what’s going to happen tomorrow. They’re basing everything on statistics and probabilities. Now, to get your own formal training, I would start with, what’s your time period or what’s your objective? So, a chart could paint a very dramatic picture. And let’s just say we see a sharp line downward. Looks like, you know, the financial apocalypse and and everything’s heading lower. Well, if you’re looking at a one minute price bar, right, and you’re only looking at a couple hours of the day’s trading, that’s not really giving you context for the broader financial markets or for that even a single company. That’s telling you that just during these few hours of trading, there’s been more selling than buying. So, I would encourage everybody to, you know, start with looking at longer term charts and you can set those functions on whatever platform you’re looking at. If you’re looking at a chart, you can look at daily closing prices or you could look at weekly closing prices and that would give you a couple years of history. That’s how you’re going to understand things like trends. Intraday, so, during the trading hours of the US market, you may see high volatility, big fluctuations in prices. If you’re just looking at a very small data set and that could steer you in the wrong direction if you’re looking at something too short term so that the time frame really matters. And then what I would also say is that it can be helpful to look at a number of different charts to get some context. So, you might look at a chart of the S&P 500 and see that the market was going down in 2022. Well, does that mean that there are no companies that you want to invest in? Not true at all. That index is made up of 500 different companies and their charts are all going to look different from each other. And so, you can find opportunities even in bear markets. So, I would just encourage everybody to keep some context in mind, look at longer term charts, and then make sure that you’re looking across multiple vehicles in terms of the index or individual securities,

Cassidy Clement

Really, you got to do your research, you got to do your homework. There’s definitely studying and practicing, whether it’s demo accounts or paper trading. And then of course, we live in the modern day. If you want to learn anything, there’s many places out there kind of like our IBKRCampus. So, we have a lot and it’s all free. You can learn all about the different elements of financial trading, but this is definitely something that you can’t just jump in and say, “Hey, I took math in high school, I’ll be just fine”. You really have to look a little bit closer and understand. I think you had mentioned some fundamental accounting or managerial accounting. You have to look to see a little bit deeper about some of those warning signs or indicators about whether or not some of these assets are actually worth getting in on.

Tyler Wood

And I would encourage all of the listeners, Cassidy, that there are a lot of free resources at CMT Association. It’s a nonprofit organization. It’s really built for and on behalf of professional money managers who use these tools, but for people who are just looking to get started, there’s a lot of free resources on our website that they could come check out just to maybe give them the right, responsible training. I did notice when markets get very frothy as they were in late 2021, everybody and their brother comes out on TikTok and YouTube and has new trading strategies. Sometimes they’re a little less sophisticated or maybe even a little irresponsible. I heard the phrase BTFD as in buy the dip over and over and over again during 2021, and that got a lot of people into trouble as the market rolled over into 2022, right?

Cassidy Clement

Yeah, it’s all about taking the opportunity to breathe and learn or even just find the definition of some of the words or phrases before you just hop on and throw in some cash. So, you mentioned a lot of technical analysis data and you’re looking at comparisons of different timeframes or maybe charts of different volatility levels. And then also just the ability to look at larger amounts of time rather than just seeing, as you mentioned, the social popularity of something within like a month, a week, a day. What exactly is that technical analysis data and where would a person looking to invest find those items?

Tyler Wood

It was actually the first president of the CMT Association, Robert J. Farrell, who spent about 50 years at Merrill Lynch as their chief equity strategist. And he just said that there are so many things that fall under the study of technical analysis, including price trends, momentum, money flows, duration and economic cycles, investor behavior and sentiment studies, supply and demand changes, volume, relationships, insider activity, monetary policy, historical precedent, and the list goes on and on and on. So, I would encourage your readers to understand that as you dip your toe in the waters, you’ll find that there is a lot more to study that can improve your investment discipline. But also, you’re going to find what works best for you. So, when you pull open a chart and you see that there are 150 or 200 indicators and different lines that you can put on your chart and new studies that you can overlay on the price data, those are all powerful tools, but using them all together is just going to create analysis paralysis. It’s going to look like a bowl of spaghetti in front of your face, which makes it very, very difficult to make an investment decision. So again, the responsible set of training is to think about what your objective is. And I use this analogy a lot when I’m talking to college undergrads: If you are looking at the weather, there are lots of different ways that you can organize that data. You could look at annual average rainfall for a country. That’s really powerful if you’re studying long term climate change and you want to understand if there’s more precipitation or less in a given region of the world. But now you’re looking at that nationally and you’re looking at it on an annualized average, does that give you any intelligence as to whether or not to carry an umbrella with you to work today?  Not at all. You need much more local context. You need a shorter time frame. You need to know what the forecast is over the next 72 hours. Right. So, it’s all weather data, but it could be very misleading if you say, “oh, well, it’s been decreasingly rainy in North America or it’s been increasingly rainy”, that doesn’t mean that it’s going to rain today. And so, the same thing applies to price data, right?

Cassidy Clement

So, the generalizations aren’t always going to be proven to be the best strategy. It takes more than just that. So, we’re mentioning all of these different patterns and ways to look for trends on charts or as you said in your example, like weather charting. But what are the most commonly used charts?  You hear the words charts every day, probably. But I know, as somebody who listens to financial podcasts myself, or Yahoo! Finance in the background while I’m doing some data work, you hear we’re going to look at blank, blank, blank chart constantly. What are some of those general or most commonly used charts that listeners can look out for and go, “Oh, I learned about that in the podcast!” I know what that is.

Tyler Wood

Of course, if any of your listeners open up their phone, you’re going to probably have a stocks app on there somewhere, even if it’s just the one that came built in with your phone. And that’s going to just show you a line chart. And that’s the most common way to look at price data. It’s just a plotted line chart with where price was at the end of the day or week or month. It gets much more complicated as you start to add studies. But let’s just talk about four things. You want to understand a price trend, right? So, you’re looking at maybe a candlestick chart. It’s very common. That’s going to show you an open, high, low and a closing price for the day or the week or the month. You could also add things like moving averages. So, when you’re thinking about price trends, you want to see what price is doing relative to a historic average. And if it’s above that moving average, that’s a positive trend. Then you’re also going to look for things like momentum. Now momentum is telling you the velocity of the price move. That’s a really powerful tool because it helps you catch those turning points. And there are hundreds of momentum studies out there starting in the 1950s with George Lane and something called stochastics. But for the sake of today’s podcast, let’s just say momentum studies are important.

Then we’re also going to want to understand things like volume. Are investors participating in the move? Is there enthusiasm for a price moving upward or moving downward? Is there a lot of volume being traded on that index or that individual security? And then the last thing is going to be volatility. And we could talk all day and night about the implications for volatility, low vol versus high volatility. What I would suggest to the young listeners is that there are some great books out there and some real experts in the field, like John Bollinger, who have helped us understand that volatility doesn’t have to be such a scary word, right? Just like the way derivatives became a really scary word in 2008, but it can do with volatility is actually understand when volatility is going to change. And that can really help us in positioning ourselves according to the trend.

Cassidy Clement

So, you’re talking about price and volume, we hear that all the time with a lot of these charts, usually they’re like this week with the price and volume of insert stock name here or we’re going to look at the vol or the volume for I know you mentioned stochastic, that’s another one, That’s another one, if you have it on your bingo card, check it off.  With all of that, there is today’s world a million pieces of information coming at you at once. Not to mention if you have your notifications on and you do have stocks on your stock app. Good for you. I hope your phone battery lasts, because they usually come through a mile a minute with all of that information. What should investors really pay attention to with their initial research? Because you come into a tidal wave of information and you can easily say, I know that name. I saw that in a college library once that was in my grandparent’s newspaper and say that that must be legit. But that’s not the case anymore. With the way that news media and the way that the news cycle goes. So what are some things that you usually use in your own research that makes you like cut through the brush a little bit?

Tyler Wood

I’ll tell you, the the most powerful thing about technical analysis is that you can form your own opinion. And what I mean by that is this year, 2023, as we were coming into the beginning of the year, I, I couldn’t hear any more bad news. We had maxed out on bad news. We’re heading into a recession. And then in February, the regional banks started collapsing. And we’re going to have a, you know, another solvency crisis. It’s going to be 2008 all over again. And the tech collapse and all of these forecasts for very dangerous, airy things that were on the horizon. Everything is I think I think people were investing in bunkers and canned corn by March of 2023. Now, the market was telling a very different story. So, when you have technical analysis in your toolkit and you can simply look at how prices are moving on the chart, then all of that narrative or the storytelling or the prognostication, what people are thinking might occur in the future, well, you’ll be prepared for it when it starts to happen, because you have technical analysis tools, but you’ll also be able to take the contrarian side of the argument, which is really powerful for professional investors. If all of the economists in the world are expecting a recession, but our stock market is showing us that we’re actually coming out of recession. That was at the beginning of 2023. And here we have made incredible gains throughout the year in the face of really bad news. And Cassidy, it’s amazing to me when I look at like the financial sector of the U.S., S&P 500 that’s been outperforming the index, meaning it’s going up faster than the rest of the market. That’s really incredible and very defiant of what my emotions would have told me. Oh, my gosh, banks are collapsing. I can’t possibly be exposed to financial sector stocks. And that’s just not been the case. So, the market does tend to be a discounting mechanism and a leading economic indicator, which means you can trust that price is never going to be restated. It’s not an estimate. It’s the real truth.

Cassidy Clement

We’re going to get into this in another podcast, but media in general, financial media could be media about aliens on Mars, anything. There’s always the sense of grabbing you with the headline. And sometimes, like you mentioned, having that extra set of knowledge in your toolkit is very helpful because the warning signs might not necessarily be on the headline, but instead on the price chart, or maybe in a recent press release or some metric that came out that might be a little bit more helpful and concrete than an analyst opinion of the latest cell phone that was released or something like that on the product. So, when we get to the point of we’ve aggregated all our research, we are starting to look through our items with our new technical analysis skills, are there some things to note when using technical analysis in your I don’t want to say research again, but understanding, comprehension, synthesis of all of these because you mentioned the spaghetti scenario in the beginning, which is so incredibly easy.

You’re in the modern world, you have a million things at your disposal, you bring them all in and you’re like, What do I do with all of this? And in my research, I’ve found you don’t want to overdo it. With 17 different indicators or ten other charts, it’ll start to look like you’re putting together a yarn board in your basement trying to figure out who murdered Colonel Mustard in the library with Clue. Right? Exactly. It goes nuts. So, there are some limitations with technical analysis. You don’t just want to make an assumption based on some trend that you said, “Oh, nobody’s thought of this”. You know, you want to make sure you take it all in. But what are some things that you would say to the less listeners to note when starting to dive in with all these new tools that they’ve learned about?

Tyler Wood

So, first things first, you set your stop loss before placing any trade. You have some risk management in place, and technical analysis is a very powerful tool for trading, specifically for risk management in your portfolio, because you can set hard and fast rules that will get you out of something before it loses. If you set your trading stops, then you’re going to be out faster than perhaps you would want to write. We want to remove emotions and bias from those trading decisions. So that’s one set of technical analysis and that those are going to be user specific. It depends on your timeframe and your risk tolerance. How much room you want to give a security that that you’ve been holding for a while. Maybe you want to be out with a 5% drop in in price. Maybe you want to be out as soon as it crosses below a moving average. Maybe you want to set your stops around an average true range. There are lots of different ways to construct your trading rules, and that’s a deeply personal process. So that’s the trading discipline and the risk management. And that’s definitely where I would start, is thinking about how you control risk. Some of the greatest traders in the world, the ones that were profiled in Jack Swagger, is Market Wizards. All they talk about, you know, Jerry Parker, who’s a dear friend now, he’s a trend following investor. He loves his losers. Right. This all goes back to an old quote from David Ricardo, in the 16th century, you want to let your profits run and you want to cut your losers short. And that’s the basics of all investing, is that you simply let things that are working stick in your portfolio and continue to accumulate gains. And those that have failed to meet your criteria or broken those stops, you get out of them as quickly as possible. Those are the trading rules. Then I would ask all the listeners to think separately and adjacent to all of that and using technical analysis for your own market research. So, there’s the trading tools side, but then you could look at concepts like relative strength. Okay, I want to add some more securities to my portfolio. Should they be commodities or should I be in bonds? Should I look at more equities? Should I maybe just hold some cash? Maybe the currency markets are where the best trends are, and a concept like relative strength can be really powerful in helping you decide where to allocate your money within your investment portfolio. So, there’s kind of two sides of the house. You can use technical analysis for all the trading rules and the risk management, but then you can also do deep dive analysis and decide where you want to start looking for opportunities. I would encourage all those listeners to think about kind of the two halves of the process, but definitely start with risk management.

Cassidy Clement

So, really also there’s the personal element because based on your risk or what you’re actually interested in purchasing for your own scenario or portfolio here you and another investor can look at a chart of something and one of you might say, this is exactly what I need, and the other one might say, I’m out of here. I’m not buying that at all. Right? So, there is a personal element which, you know, does it fit you? Is it in your best interest to look at this so that that’s another a little bit more per consumer or a per investor element?

Tyler Wood

I’ll give you a story right along those lines, Cassidy, at well, a big mutual fund company, let’s call it. They’ve got a bunch of professional portfolio managers that have been doing this for decades, and technical analysts might bring in some ideas to these PMs.  And the same idea for a growth equity portfolio manager, somebody who wants the the great story, the expanding company. You know, that’s really attractive to a momentum investor that’s also the absolute sell for a value investor, meaning something that has gone up 50%, a value investor thinks “I got to get out of that. I want something that has been beaten down 80%. I want to find the stuff that’s really cheap because that’s their philosophy and their approach”. You can use technical analysis as a value investor or a growth investor. My point is that it’s just the different investment styles that would dictate what looks really good versus really bad. And I think most of the arguments on Twitter could be settled just by naming the timeframe and the approach that somebody is taking.

Cassidy Clement

Oh, absolutely right. Imagine half of the stuff. I mean, it’s like for me personally, it’s like talking about the 2008 Phillies versus the 2012 Phillies. Yeah, we’re talking about two totally different eras. Regardless, they won a World Series. Yeah, but I know if we were talking about one over the other, I would be having very different comments about my own sanity. Well, thank you for joining us, Tyler. This was awesome. You brought up some really good points.

Tyler Wood

Absolutely. It’s a pleasure to talk to all of the future generation of finance professionals or just folks who are looking to manage their own accounts in a more responsible way. So happy to be here. Awesome.

Cassidy Clement

So, as always, listeners can learn more about an array of financial topics for free at ibkrcampus.com. Follow us on your favorite podcast network and feel free to leave us a rating review. Thanks for listening everyone.