Thre are 2 important things in the stock market when to buy a stock and which stock to buy.
I am sure most of you after going through our Groww YouTube channel have now learned about selecting fundamentally sound companies.
Now that you have a pool of companies after doing fundamental analysis, Let’s use Technical analysis to help us in selecting stocks.
In today's video, we will tell you about the Top 5 technical parameters which you should check before buying stock.
First things first, What is Technical Analysis?
First, we will understand what is technical analysis.
Technical analysis is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume.
While most investors analyze stocks based on fundamentals such as revenue, operating margins, etc.
Technical analysts believe price patterns repeat themselves and that recognizing these patterns is the best way to beat the markets.
It is a good practice to combine the Fundamental analysis with technical analysis of the company to make the best of both worlds.
Now for a beginner technical analysis may seem difficult and scary and it is easy to be lost in the array of topics that it covers.
However, we shall discuss the top 5 Indicators that can be used individually or in conjunction to pick stocks.
One important thing, whatever examples we showed in this video were only for educational purposes.
Please don’t treat them as any kind of buy/sell recommendations.
These are just examples to explain the concepts to you.
Now let’s quickly look at the first indicator which is Moving Averages.
This is by far the most common indicator that traders and investors turn to while investing or trading.
Moving average is a tool that smoothens out the price data by simply taking the average over a specified period of days.
The advantage of using a Moving average is that it cuts out noise in the chart and helps give a basic sense of the direction of the market.
It is relatively easier for the naked eye to spot trends using moving averages than trying to predict trends using the price chart.
Let’s understand how to use this indicator with an example.
In the video, we can see the ITC chart in the daily timeframe.
We’ll go to the top right corner and select the indicator dropdown menu.
Over here we search for the “Moving average” indicator and apply it.
So after applying the moving average indicator this is how it will look on the chart.
The line chart is embedded in the candlestick chart.
Please note that the default setting for the moving average indicator is 50 days.
Now we shall right-click on the moving average indicator to change the parameters of the indicator.
For this particular example, we need a 200-day moving average, hence we change the period setting from 50 to 200.
We can further play along with the settings by changing the color if needed.
So one way to use this 200-day moving average is:
If the price is trading above the 200-day Moving average then the stock is considered bullish
and if the price is trading below the 200-day Moving average, it simply denotes that the stock is bearish.
Most investors generally look for buying a stock when the price crosses 200DMA from below the line
and they short the stock when the stock falls below the 200 DMA owing to its bullish and bearish nature.
In this example, we saw the price crossover that happened with the 200 DMA line from below the line which constituted a potential buy setup.
We saw a rally from 200 levels to 270 levels.
The next technical parameter is RSI stands for Relative Strength Index.
It is a momentum indicator that measures the magnitude of price change which in turn helps us to evaluate the overbought and oversold conditions of a stock.
A 14-day period is generally the most sought parameter RSI.
Usually, an RSI value below 30 is considered oversold or undervalued and might be up for a trend reversal
Similarly, an RSI value above 70 is considered overbought or overvalued and is likely to be headed for a trend reversal.
Let’s now understand how to use RSI Indicator with a practical example.
In this video, we have the chart of Adani Green Energy Ltd in a daily time frame.
We quickly again go to the top right corner and select the RSI Indicator.
Note the default RSI setting is of 14-period. We shall not change the settings of RSI in this case.
Also, the RSI indicator does not overlay on the price chart, we shall get a separate chart for RSI which will comprise 2 lines which are at 30 and 70.
One way in which we can use this RSI indicator is to buy the stock whenever the RSI indicator crosses the 30-line form below.
Now in this example, we saw that the RSI value was below 30 for quite some time and the market was bearish.
Once we saw the RSI value cross the 30 levels from underneath the line, we saw a potential mean reversion setup.
From therein on, the price rallied strongly in the upward direction.
We further can see the exact point where the RSI value crossed the 30 levels with the help of a vertical line drawn to understand better.
The bull run in this example after the RSI crossover looks very strong.
Next, let's talk about the Bollinger Bands
Bollinger bands are a volatility indicator used to measure the overbought and oversold conditions.
They consist of a simple moving average, and 2 lines plotted at 2 standard deviations on either side of the central moving average line.
The outer lines make up the band.
When the market is quiet, the bands contract and when the market is loud, the bands expand.
In simpler words, the band contracts when there is less volatility and is range bound and the band expands when the market is volatile and is trending.
Let’s take an example to better understand this indicator.
In this video, we have taken a chart of Tata Motors in a daily time frame set.
We go ahead to the top right corner to select the indicator.
In the dropdown box, we search for Bollinger bands and apply them to our price chart.
The bands act as dynamic support and resistance levels and they also work as mean reversion indicators
i.e. whenever the price bounces from one side of the band to the other, it generally returns to the central line which is the moving average.
Traders generally use this concept and if the price hits the bottom of the band, then place a buy order with a stop loss just below the band to protect against a breakdown.
The price should revert towards the average, and maybe even to the top band, where one can take profits.
Sometimes traders put stop loss under the band to minimize their losses.
Now, on your screen, you can see the price bouncing back from the lower band and rallied up towards the upper band.
In this manner, you can use Bollinger bands to identify support or resistance levels.
We should seek reversion candlestick patterns while trading Bollinger bands.
In our last example, we used a hammer as a confirmation candle to go long.
Please note it would be wise to trade in the direction of the trend and not against the trend.
Stochastic Oscillator- This is yet another favorite indicator amongst the traders.
A stochastic oscillator is a momentum indicator and can be used to find where a trend might be ending.
This indicator just like RSI is used to determine if a stock is overbought or oversold.
Let us understand the Stochastic oscillator on the charts, as usual, go to the indicator dropdown box and search for the stochastic simple.
Stochastic is usually plotted on a separate chart like RSI and consists of 2 lines.
The stochastic oscillator is range-bound, that is it can have values between 0 to 100
Typically readings over 80 are considered to be in the overbought range and readings less than 20 are considered to be in the oversold range.
When the stochastic value is below 20, the general notion is that the market is oversold and an Uptrend is likely to follow.
However, these are not always indicative of impending reversal, very strong trends can maintain overbought or oversold conditions for an extended period.
Now, let me show you a practical example of how this indicator can be used.
This chart is of Reliance Industries in the daily timeframe.
We can see that the stochastic value reached the oversold region of 20.
During that time Reliance Industries started trending and had a good run.
We should always seek reversal candlestick patterns when we are trading with stochastic indicators.
i.e when the stochastic value is below 20, we need to check for bullish candlestick patterns,
and when the stochastic value is over 80 we need to look for bearish candlestick patterns.
Supertrend- This particular indicator has created quite a lot of buzz in recent times
and as the name suggests, Supertrend is a trend-following indicator just like moving averages.
A chartist using 'Supertrend' needs to key in two important parameters,
namely the 'period' which refers to the number of days, and the ‘multiplier’ which refers to the value by which the Average True Range i.e. ATR is multiplied.
Let’s understand more about this indicator via a chart.
First things first, we go to the top right corner and type for Supertrend in the indicator drop-down box.
This indicator has mainly two settings as mentioned previously one is called the “period” and the other is called the “multiplier.”
However, one can play around with these settings and find the one which best fits a particular stock.
The Supertrend indicator when plotted on the chart shows the arrows for signals to buy and sell the stock.
This is by far the most direct indicator which gives explicit Buy and Sells signals on the chart with the help of green and red arrows.
A Supertrend indicator is best used in tandem with other indicators like RSI or stochastic to increase the signal quality.
It is important to note that the Supertrend indicator performs badly in a sideways market and can give a lot of false signals.
Now, let me show you a practical example of how this indicator can be used.
The above chart is of Adani Power in a daily time frame, we can see a good uptrend when the Supertrend indicator gives a buy signal.
This is how you can use the Supertrend indicator to identify trends.
Thus, we come to the end of today’s video.
Investors who are planning to buy stocks for the long term can use these indicators as a filter or trigger point to buy the stocks.
They can also use multiple indicators in tandem to increase the signal quality.
It is highly advised to back-test this strategy or variations of these strategies on multiple stocks and on multiple time frames to arrive at the best trigger point that suits your style of Trading.
So which of these indicators would you use? Do let me know in the comments below.
Hope you all learned something valuable today
Also, be sure to follow our Trading channel “Trading with Groww” for more informative and in-depth content on Trading.