Before I get all the hard core chartists worked up into a tizzy, let me say that I do not think chart reading a.k.a. technical analysis is worthless. In fact I use it every day the market is open in some capacity. Different indicators such as stochastics, the relative strength index and levels of support and resistance are things I look to glean insight from more often than not. So there you have it, I do use technical indicators and I wouldn’t think about making a trade without at least studying a stock’s chart for a New York minute.
The problem that I have seen people creating for themselves is one of over reliance on technical analysis. And I say this from experience. The scenario usually plays out something like this: A newbie trader makes a few trades. He gets nowhere fast, and has likely lost some money since he started his trading adventure. He starts to get a little discouraged but still thinks he can make it as a trader. Then, one day he sees a micro cap stock make a huge one or two day move. The type of a move that can turn $1,000 into $5,000…maybe even more. Get the picture? A huge “breakout”.
He suspects that there may have been one magical technical indicator that could have “tipped him off” about the impending move in that stock. After taking a look at that particular stock chart, his eyes light up! “There it is”, he thinks to himself, “If I would have just saw that stochastic curling up over the 40 level, I could have made bank!” Then, with a renewed sense of optimism, he goes and buys the first stock he thinks is about to make a move based on the chart observation I just mentioned (stochastic).
Result? It doesn’t work out like he hoped for. The newbie trader I am speaking of is not some imaginary persona I conjured up to make myself look smart. Nope. That novice young man was ME. Yes indeed. But it was a lesson learned. A very useful and important one. It helped me to realize there are many variables as to why a micro cap stock (penny stock) makes a big short term move to the upside-and to the downside as well in some cases.
I don’t remember the exact scenario with that stock. I actually tried to dig up what stock it was…to no avail.
So what’s my point? Glad you asked.
It is simply this: Technical analysis should only be considered as a “tool in your tool belt”. Why? Because there are other forces at work, especially in micro cap stocks that you need to pay more attention to than technical analysis. What other things? I can’t possibly name them all in list format. Maybe if I drank a 64 oz. of Dunkin’ Donuts Turbo coffee I could, but I’d like to go to bed tonight at some point.
But I will tell you one very important thing to familiarize yourself with on any stock you are considering making a trade on, whether it’s a microcap stock or not. Ready? Here it is:
The story line of a stock.
Vague enough for you? Well, have no fear because my next article will go more in depth about it. Basically, it is taking the time and effort to understand what recent events have had an impact on a stock’s value, and equally as important, what current and future events will likely have an impact on a stock. More details in the next article from me.
To conclude, I want to say that there really is no magic bullet type technical analysis strategy. It is helpful. But it is just a tool. Growing a small trading account into a life changing sum of money requires you to position yourself better than someone who is only willing to look at stock charts. You have to dig deeper.
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