HOW TECHNICAL STOCK ANALYSTS “SHAMPOO”
One in two people in the world have suffered from dandruff at some point in their lives, according to the website of popular anti-dandruff shampoo Head & Shoulders.® That’s interesting, because a Gallop study also discovered a one-in-two statistic: just over one in two members of the U.S. population invest in the stock market, with a far smaller number of those using head-and-shoulder technical analysis to help with stock selection.
A head-and-shoulders stock chart has three peaks, with the two on the outside close in height, and the middle peak the highest. In technical stock analysis, this chart formation predicts a bullish-to-bearish trend reversal, meaning that an upward trend is nearing its end.
- The “left shoulder” shows a price rise followed by a price peak, then followed by a decline.
- The “head” shows another price rise forming a higher peak.
- The “right shoulder” shows a decline followed by a rise lower than that of the “head.”
How do stock traders use this information? Traders typically wait for the stock price to move lower than the “neckline” (just after the peak of the right “shoulder”) and then sell that stock.
Head-and-shoulder charts are just one of several tools employed in technical analysis of stocks, which uses charts, patterns, and trends in the past to forecast the price movements of a stock in the future.
This is in contrast to money management strategies that utilize fundamental analysis, which studies each particular company’s financial statements, management process, and industry to forecast the direction in which the price of that stock is likely to move. Fundamental analysts try to identify whether a stock is under-priced or over-priced, looking at factors intrinsic to the company itself, rather than general patterns or trends.
In the technical analysis school of thought, the “punch” is in the pattern. The price of a stock—like the price of everything else—is a matter of supply and demand, technical analysts believe, so they focus on generating and interpreting charts of the price and volume histories of stocks, using those to predict future movement in stock prices. The “head-and-shoulders” chart is actually one of the less complex formulas used by technical analysts. Other devices (there are more than 200!) include:
- Fibonacci’s Golden Ratio
- Elliott Wave market forecasting
- Gann Theory
- MACD (moving average convergence/divergence)
In essence, technicians attempt to forecast the WHEN (the right time to get into or out of a stock), as compared with fundamental analysts, while fundamentalists focus on the WHAT (which securities to buy into or sell out of).
Which is better? Well…. Fundamental analysis is more theoretical; technical analysis might be considered more practical. Whatever combination of “shampoo” you select, the goal is the same—clean hair! As P. Saravanan writes in Financial Express, fundamental and technical analysis are both useful and valid, and you can use one or both as long as you are making money!