Technical analysis (TA) is useful to everyone -- not just the short-term trader or intermediate-term speculator, but to the long-term investor as well. The purpose of this course is to introduce you to some basic analysis techniques that you can begin using immediately. This course will not instantly turn you into a competent technical analyst. The objective is to introduce you to a structured approach to market analysis that will help you to perform a quick top to bottom assessment of the market, to decide which actions are appropriate, and to spot opportunities to exploit the situation. Competence will come from daily practice and your effort to develop insight.

Technical analysis will not predict the future, but it will help you assess the market environment so you can act in concert with the dominant context. To do this we use a simple process involving three essential analysis steps:

(1) Determine the market trend; (2) Evaluate the market condition; and (3) Identify and initiate actions that are most compatible with the trend and condition of the market.

Note that in the first two steps we acquire information to help us determine which actions to consider in step three. We let the market tell us what to do because we want the tide of the market working in our favor, not against us. For example, if the trend is up and the market is oversold, we would look for opportunities to go long. Or, if the trend is up but the market is overbought, we would become somewhat defensive, tightening stops in anticipation of a price correction.

Let me repeat it for emphasis. We don't decide what we are going to do until after we have determined what actions the market will best accommodate and support based upon the trend and internal condition.

Another important aspect of this process is that we are not trying to forecast what the market will do, rather we are directing our efforts toward analyzing and responding to what we can observe about current market conditions. We cannot see the future, but we can respond intelligently to the environment we can observe.

I should emphasize that this course is not the last word on technical analysis, nor is it meant to be all inclusive. Its focus is the distillation of my years of experience and observation, and I believe it will provide an excellent foundation for new students of the discipline, as well as a useful perspective for experienced practitioners.

On the Main Menu there is a section that contains links to "Trend and Condition Charts". Each page contains a series of charts arranged in a way that you can quickly review the trend and condition of a specific market index over the three time frames primarily addressed in our decision making. If you are a beginner, your daily routine should be to first review the Trend and Condition page for the S&P 500 Index. You do not need to limit your perusal to that one page, but, if you do nothing else, study that page every day until the light starts to come on. If you are an experienced technician, there is no faster way to get a complete picture of what the market is doing.

The discussion that follows will prepare you to get the best use of the Trend and Condition Charts.

DETERMINING THE TREND

The trend is the observable direction of the market -- up, down, or sideways -- and, by acting in concert with the market trend, we significantly increase our odds of success. The reason for this is that the trend of the market normally indicates the direction of most stocks and sectors. In fact, during a strong bull market over 90% of stocks can be trending upward together, which means our odds of picking a winning stock are nine out of ten. Why would we try to short against a market tide that strong?

When we analyze the trend, there are three time frames we will address -- short-term (days to weeks), intermediate-term (weeks to months), or long-term (months to years). These are broad definitions and can be shifted down into shorter time frames as suits the individual (i.e. short-term could be hours to days), but it is important to always be aware of the trend in three consecutive time frames because they are interrelated, and actions must consider all three.

Here's how it works. For the purpose of this discussion, the target time frame (where we will be looking to hold positions) is the intermediate-term (IT). To determine the kind of IT positions we can take, we first look at the long-term (LT) trend. (This concept was presented by Dr. Alexander Elder in his book, "Trading for a Living"; elder.com) If the LT trend is up, we can be IT long or neutral. If the LT trend is down, we can be IT short or neutral. (Being neutral, which is hedged or in cash, is always an option no matter what the trend.) Once the LT trend is identified, we wait until the IT trend is moving in the same direction as the LT trend before opening compatible positions, and we use information from the short-term trend to get optimum execution on new positions.

The longer-term trend is the dominant and most important trend, but we must be attentive to the shorter-term trends because that is where long-term trend changes can first be detected. The longer-term trend determines our strategic stance, but the shorter-term is where we make our tactical moves.

There are many ways to define the price trend, but let's make it simple and use moving averages. A moving average smoothes price movement over a specific period. For example, a simple 20-day moving average is the average price of the last 20 days. We use exponentially weighted moving averages (EMAs), which are similar to simple moving averages but are weighted to recent prices. (To learn more about moving averages CLICK HERE to read our Glossary article on that subject.) The number in the moving average (MA) name refers to the number of periods embraced by the MA. For example, a 20-EMA covers the last 20 data points in a series of closing prices. The kind of period is defined by the kind of chart -- on a daily chart it would be 20 days, a weekly chart 20 weeks, a monthly chart 20 months.

LONG-TERM TREND: To determine the long-term trend we will use a moving average crossover signal on a weekly or monthly chart. For this we use a "fast" and "slow" MA, which means that the fast MA is calculated on fewer periods and will respond to price changes faster than the slow MA. First let's look at the monthly chart (each data point represents one month), where we use a 6-EMA and 10-EMA (6-month and 10-month periods). We define the trend as being bullish when the 6-EMA is above the 10-EMA, and bearish when it is below. The 10-year period I have selected is a perfect example of how well this methodology can work. It doesn't always work this perfectly, but over all it is very effective in correctly identifying the trend.

Note how the 6-EMA crossed above the 10-EMA at the end of 1994, signaling the beginning of a new long-term bullish trend that lasted until late 2000. Then the trend changed to bearish as the 6-EMA crossed down through the 10-EMA where it remained for over two years during the worst bear market in decades, finally crossing up again in spring 2003.

(Editor's Note: The moving average combinations we have chosen are not "magic bullets." We have observed that they are effective and have embedded them in our charts for easy reference, but other combinations you might use could also be effective.)

While the EMA crossovers offer an unambiguous way to determine the trend, there are other nuances that are useful in refining our trend assessment. Note that there are times when the price index crosses through the EMAs, as well as times when one or both the EMAs move counter to the trend. Most notably this occurred in 1998 during a price correction of about 20%. Any time one or more of these actions occur, you should consider the trend to be neutral, leaning toward bullish or bearish depending upon how many of these counter trend conditions exist.

Please study this chart carefully. The concept is elegantly simple, yet incredibly powerful. Imagine how much better off most investors would be if they merely used the information conveyed by this chart as a basis for deciding the amount and kind of market exposure they should have. This is not some esoteric market timing formula. It is common sense!

It is important to understand that trend changes detected by this or any other method do not necessarily imply any immediate or specific action need be taken. Initially, it should be viewed as just one part of the information we need to make buy/sell/hold decisions.

The monthly chart is effective, but we have to wait until the end of the month close before the numbers are "official," so I have developed a similar mechanism for a weekly chart so that we can have an official reading on the long-term trend at the end of each week. On the weekly chart we use the 17-EMA and 43-EMA, and the same rules we use for the monthly chart apply here.

Note that the EMA crossovers occur at about the same places, and, except for the added detail from weekly closing prices, there is very little difference between the two charts.

INTERMEDIATE-TERM TREND: To determine the intermediate-term trend we will use the 20-EMA and 50-EMA on a daily chart. Again, the same rules apply regarding EMA crossovers, EMA counter trend movement, and the relationship of price to the EMAs.

Since the EMAs are being derived from daily data they are much more active than the weekly or monthly EMAs, and they will detect strength or weakness sooner. You can see that the daily 20-EMA crossed up through the 50-EMA much earlier than the weekly or monthly EMAs in the beginning of the 2003-2004 bull market. You will also note that the 20-EMA signaled an intermediate-term trend change in March 2004, but there was subsequently a series of whipsaws which can occur when the market moves sideways, as it did from December 2003 to May 2004. Such action can be frustrating, but remember that it is useful information about the market trend that should be considered when making trading decisions.

SHORT-TERM TREND: To determine the short-term trend we will simply use the direction of the daily 20-EMA. If it is moving up, the short-term trend is bullish, and vice versa.

Again, I must emphasize that we are not at a decision point during the trend analysis phase. We are simply gathering information. The next step of that process is to evaluate the market condition.

EVALUATING MARKET CONDITION

When we speak of the "condition of the market, we are referring to it being overbought (OB) or oversold (OS). We can think of buying and selling as being like alternating manic and depressive phases that cause the zigzag progress of price indexes. First, buyers overwhelm sellers in a wave that drives prices up. Then buying pressure becomes exhausted and the market is described as being overbought. Next, profit taking and selling begin as the sellers take control, and prices are pulled back down until selling reaches a point of exhaustion and the market is oversold. When these alternate pressures are about equal, the market moves sideways, otherwise, the rising or falling trend tells us whether buyers or sellers are the dominant group. By using certain indicators, we can assess the OB/OS condition of the market and get some clue as to when price reversals may occur.

Just as with trend analysis, we are concerned with the condition of the market in the short-, intermediate-, and long-term time frames; therefore, we use indicators designed to detect the condition of each of those time frames. The object of this analysis is to identify optimum points for entry or exit within the trend, or to simply be aware of conditions that demand more caution. For example, if the market becomes overbought in an intermediate-term up trend, we should become more cautious regarding current market exposure, and it would not be considered an optimum time to open new longs. If the market were oversold in the same up trend, we should anticipate an upward shift in price momentum and be looking for opportunities to increase market exposure.

As with the trend, conditions in the longer-term are more important and powerful than those in the shorter-term.

LONG-TERM MARKET CONDITION: One of the best gages of long-term market condition is the weekly PMO. On the chart below red and green dotted lines mark the general range between the OB and OS levels. In this case the range is from about +5 to -5, which is fairly common; however, you should always check because each price index has its own range.

You probably also notice that weekly PMO direction changes that occur at range extremes also tend to be fairly reliable early indications that the long-term trend has changed. The PMO direction also reveals the dynamics of market condition. It the PMO is rising, it means that conditions are strengthening, and if it is falling, conditions are getting weaker. This is generally true of all indicators. The next chart shows the weekly PMO range for the S&P 500 Index from 1940. It demonstrates the relative consistency of the range for this index.

Finally, we have a weekly chart of the Nasdaq Composite Index, which has an overbought PMO spike in 2000 and an oversold PMO spike in 2001. The point to be made is that we do not let exceptions establish the limits normal range. Clearly the normal range is where we have placed the red and green dotted lines.

The next chart is another favorite of mine because it is derived from price movement of each of the individual stocks traded on the NYSE. In the broadest sense, when a price index is above it's 200-day moving average, it is bullish. By tracking the percentage of stocks above their 200-DMA, we get a solid grasp of the long-term condition of the market. This chart also illustrates how overbought conditions in a bull market do not always result in price tops.

INTERMEDIATE-TERM MARKET CONDITION: A good measure of intermediate-term market condition is the daily PMO. On the chart below we can see the daily PMO range for the S&P 500 for 25 years. It is obvious that the range is quite different at different periods, but I would say that the normal range is about +2.5 to -2.5, which is fairly typical for broad market indexes.

At the intermediate-term level, we have quite a number of market indicators based on breadth (advances and declines) and volume. I prefer to use the price based indicators first, but breadth and volume indicators can offer a more robust view of market internals. Below are some of the indicators we use for intermediate-term analysis. For now, we will not delve into each one in any detail -- that will be part of your self study effort as you read our documentation, and work to understand the construction and theory behind each indicator.

At this point, just study the charts and note how the indicators travel within their ranges, and what happens to price when the indicators get overbought or oversold. On the Trend and Condition chart collections we group together indicators from similar time frames, so you can see how indicators resulting from different calculations compare. We expect to see similarities. When there are significant differences, it deserves special attention.

By the way, on our web site we always show the indicator along with the relevant price index. The whole point of indicators is to observe how prices behave in relation to the indicator. This should be your focus every time you look at a chart.

SHORT-TERM MARKET CONDITION: The difference between intermediate-term and short-term indicators is the frequency with which the indicator moves from overbought to oversold and back again. And, because short-term indicators are more active, the tops and bottoms they identify are less important, except where they coincide with intermediate-term tops and bottoms. Below are a selection of short-term indicators found in the Trend and Condition chart collections.

Why are there so many indicators? Each indicator looks at the same data a little differently than the others, and we personally like to compare several because divergences can provide early warning of developing problems.

TREND BIAS: Trend Bias is the tendency of technical setups to resolve in favor of the trend. The stronger the trend, the stronger the Trend Bias. This is a new term, and an enhancement of an old concept: The trend is your friend.

One of the problems we face as technicians is that technical situations don't always turn out the way "the book" says they should. While the term certainly applies to standard chart formations, such as head and shoulders, double top, support and resistance, etc., we most often encounter it with simple overbought and oversold conditions detected by oscillators.

For example, during a bull market, technical indicators can become quite overbought, but prices, instead of correcting as we normally expect, often keep moving higher or simply consolidate. There are certainly many examples of this during the rally from the March 2003 market lows, and during that period, technicians who had become proficient in picking overbought tops during the 2000-2003 Bear Market were suddenly getting their heads handed to them as their favorite indicators began to betray them time after time. Yes, there were some corrections, but they were small, resulting in a series of higher lows.

During the same period, oversold conditions proved to be quite reliable bottom identifiers, although I should emphasize that oversold conditions tend to be fairly reliable regardless of Trend Bias. Nevertheless, during down trends reactions from oversold conditions will usually precipitate some kind of bounce, and deeply oversold conditions always occur near a tradable bottom. Conversely, extreme overbought conditions are very often the sign of a rally initiation, not a top.

The chart below demonstrates the nuances of Trend Bias.

There are two areas enclosed by blue dotted lines which show areas of positive trend bias during the bull market. Note how in most cases the weekly PMO tops do not result in significant price tops because the trend is up and the correction of overbought conditions is manifested internally, not in the price index. Conversely, PMO bottoms are fairly reliable indications that higher prices are on the way.

The area surrounded by the red dotted lines encompasses the bear market. Trend Bias now favors the downside, and PMO tops become reliable indications that important price tops are at hand. PMO bottoms are still fairly reliable confirmations of price lows, but the rallies that ensue are often short, and even the strongest rallies fail to break the price trend.

DAILY CHART REVIEW: We have a small number of Trend and Condition Chart pages. Each page has a large selection of charts related to a single index. If you only have a limited time, look at the Trend and Condition Charts for the S&P 500 Index. That is usually the best picture of the broad market. If you can squeeze another one in, review the page for the Nasdaq 100, because it will give you insight into tech stocks, which tend to lead the market (both ways).

TAKING APPROPRIATE ACTION

Having first analyzed the trend and condition of the market, we now know what kind of action the market will support best, and we are far ahead of most investors, who usually skip these steps entirely. The next step is to look for actual stocks and mutual funds that we can buy or sell. This subject is far too complex to cover in great depth here, but we will get you pointed in the right direction as to where you should be looking.

SPECIALIZE BY USING TRACKERS: Some of the most successful traders trade only one stock. They know the issue inside out, and gain an intuition about how it trades. We are aiming for a broader approach here, but specialization is still important.

To help you narrow your focus we have developed Trackers. These are tool sets that have all the inforamtion you could possibly want on a specific group of securities, like Fidelity Select Funds, Rydex Funds, Dow 30 stocks, and ETFs (Exchange Traded Funds).

You can choose the one that suits you, but, unless you are a professional, keeping track on more than 30 or 40 stocks or funds will be more than you can handle, so we highly recommend that you use our ETF Lite Tracker. The ETF Lite Tracker focuses on a list of 30 ETFs covering a broad range of market indexes and sectors.

Like all our Trackers, it comes with a daily report, two chart books (6-mo and 2-yr), and an Excel spreadsheet. We recommend that on a daily basis you review at least the 6-mo chart book, and download and print the spreadsheet (sort by PMO rank first) for review. If you do this daily exercise, you will be amazed at how knowledgeable you will become of what is really happening regarding market index and sector rotation. And it is here you will be able to watch promising trading setups as they develop.

To identify and exploit technical setups you will have to learn about relative strength rotation, as well as learn how to use charts and indicators. There are thousands of books written about this stuff, so don't try to learn everything at once. You'll get a good start if you next read the article on Using the PMO (Price Momentum Oscillator). The PMO is an excellent technical indicator and relative strength tool.

WHAT DO YOU FIND?: Once you have assessed the trend and condition of the market, specific actions will be suggested. For example, if the market oversold and in a rising trend, we should be looking for (and expecting to find) evolving opportunities to open new long positions. The degree to which we actually find such opportunities is also very important feedback regarding (1) the correctness of our market initial market assessment, and (2) the breadth behind the market trend. In other words, if we are expecting to find opportunities to go long, but we don't find many, either our market assessment is wrong, or the rally is in its final phases. If all you can find are opportunities to go short, you'd better go back and start from the beginning.

For example, in March-April 2003 the bull market was beginning, and nearly all stocks were generating PMO crossover buy signals. Charts were deeply oversold, and the potential for gain was robust. It would have been hard to pick a loser.

In August 2003, after the June-July consolidation, we again saw plenty of stocks that had corrected, were modestly oversold, and beginning another leg up. But there were also a number of stocks that were rotating out of favor. Good choices were in abundance, but more selectivity was needed.

In May 2004, after a consolidation lasting several months, the picture was much more fragmented due to the vigorous rotation that had occurred. The picture was muddled, and clear opportunities were much harder to find. There were even some opportunities to short, but they were not yet plentiful.

Taking only the best opportunities at each stage would automatically reduce your exposure as the field became thinner.

SUMMARY

Before we even think of buying or selling, we need to know the trend and condition of the market. This will tell us how the tide is running so we can take actions that will ride on the tide, not struggle against it. By specializing in a short list of stocks or mutual funds, we'll add sharpness to the edge we are honing. Even at the stock selection stage, we will continue to receive additional information about market conditions and feedback as to the correctness of our analysis.

The entire top to bottom analysis process should be done every day, so that we can develop a strong intuition about what is happening in the market and in the list of trading vehicles we are tracking.