Key assumptions for TA

• Liquidity. Heavily-traded stocks allow investors to trade quickly because there are many buyers and sellers. Thinly-traded stocks are more difficult to trade because there are few buyers or sellers.
• No Artificial Price Changes. Splits, dividends, and distributions are the most common “culprits” for artificial price changes.
• No Extreme News. Technical analysis cannot predict extreme events

Of the many theorems put forth by Dow, three stand out:

• Price discounts everything
• Price movements are not random
• “What” is more important than “Why.”

Overall Trend. The first step is to identify the overall trend. You can do this with trend lines, moving averages, or peak/trough analysis. For example, as long as price remains above its upward-sloping trend line or specific moving averages, the trend is up. Similarly, the trend is up as long as higher lows form on pullbacks and higher highs form on advances.

**Support.** Congestion areas and previous lows below the current price mark the support levels. A break below support would be considered bearish and detrimental to the overall trend.

**Resistance.** Congestion areas and previous highs above the current price mark resistance levels. A break above resistance would be considered bullish and positive for the overall trend.

**Momentum.** Momentum is usually measured with an oscillator such as MACD. If MACD is above its 9-day EMA (exponential moving average) or positive, momentum will be considered bullish or at least improving.

Buying/Selling Pressure. For stocks and indices with volume figures available, an indicator that uses volume is used to measure buying or selling pressure. When the Chaikin Money Flow is above zero, buying pressure is dominant. Selling pressure is dominant when it is below zero.

Relative Strength. The price relative is plotted as a line that divides the security by a benchmark. For stocks, the price is usually divided by the S&P 500. The relative strength plot indicates if the stock is outperforming (rising) or underperforming (falling) the major index.

The final step is to synthesize the above analysis to ascertain the following:

• Strength of the current trend.
• Maturity or stage of the current trend.
• Reward-to-risk ratio of a new position.
• Potential entry levels for a new long position.