How to Invest – Part 1: Technical Investing

Over the past few years I’ve had a number of friends ask me how to get started in investing. Now, I’m not a professional but with a finance degree and with a few years short of a decade of experience, I definitely have a leg up on many people my age and older. To my friends’ credit though, they’re headed in the right direction. According to a May 2013 Gallup survey, stock ownership by individuals in the 18-29 age group stood at a mere 27%. Furthermore, only 52% of all Americans say they own or jointly own stock, an all time low since the inception of the survey. The following are my thoughts on how to get started as well as a little background in one of the many investment philosophies out there.

Online Investment Accounts

Getting Started:

First thing first, you have to set up an investment account. This can be done at many websites, with the most notable being TD Ameritrade, E*TradeScottrade, and Fidelity. Some accounts require a minimum investment, so check the fine print for those details. Furthermore, you’ll want to look to see what commission costs are for buying and selling stocks. For example, TD Ameritrade charges $10 every time you make a purchase of or sell a stock holding. Once you’ve started your account, my recommendation would be to not start buying into anything unless you have a minimum of $500 to invest because the risk vs. reward is too heavily affected by the cost of trading.

As an example, suppose you buy five shares of XYZ company for $100. Immediately, you only have $490 of equity because of a $10 trading fee. Now say you make 10% in your first year, (50 years annualized return of the S&P from 1964-2013 is 9.98%). That’s $49. Now you decide to sell and hold on to your gains. Well that also costs you $10. So in total you now have $529 or $29 more than you started with. But if you lost 10% you’d end up with only $431, a loss of $69. If you invest any less, the effects are even worse.

Of course, some of these investing platforms allow for individuals to trade certain common ETF’s commission free. This may be a good option for a beginner who just wants to learn the flow of the market before having to worry about factoring in trading fees in their returns.

Choosing an investment philosophy, diversification and strategy:

One of the most critical aspects of investing revolves around choosing these three aspects of your portfolio. As a beginner it’d be best to start out with one of each and then, as you gain experience, try testing out different areas of the market. For young investors, it is acceptable and often encouraged to have a portfolio breakdown of at least 80% in stocks. For most however, this may be 100% as you are starting up your portfolio. A strategy revolves around having certain buy and sell rules around your investments. For example, if you make a 35% gain, you sell all the time every time. Or if your stocks breaks a certain resistance line (will be discussed later), then you automatically sell. An investment strategy is without a doubt the hardest part of investing. Unlike computers, humans can not help but falling prey to emotional investing. Here’s some ways to try to curtail the effects.  An investment philosophy is the principles by which you decide an investment decision. Many different philosophies exist. They include:

  • Value Investing – Seeking relatively undervalued stocks and believing they will eventually produce strong returns.
  • Fundamentals Investing – Identifying companies with strong earnings prospects.
  • Growth Investing – Buying into companies that have promising emerging products or services that hold promising growth potential
  • Technical Investing – Examining past market data to look for hallmark visual patterns in trading activity to make buy and sell decisions.

For this article however, we’re going to focus on technical investing. Although this philosophy may require a good eye and a bit of luck, it doesn’t require memorization of complex formulas or any sort of analysis on the investors behalf aside from just taking a look at a stock’s past charts. And honestly, what part of investing doesn’t require a bit of luck?

Technical Investing Basics:

Once you’ve set up your account, it’s time to start looking for a stock to invest in. There are plenty of technical investing chart patterns to look for but I’m only going to focus on the two most common, Ascending and Descending Triangles and Double Top and Bottoms.

Ascending and Descending Triangles:

With an ascending triangle, an investor is looking for a steady uptrend in a stocks trading price in correspondence with a ceiling resistance at a certain price point. In the figure below on the left, you can see an example of this trend. The top horizontal line is the resistance line, a price point that a stock will not surpass in a matter of weeks or months. You can also see the upward angled diagonal line following suit over the same time period. If the stock price surpasses this resistance line it is a good indicator for a trader to buy the stock.

Investopedia

This is an example of an Ascending Triangle chart from General Electric from the beginning of February to the middle of April

This is an example of an Ascending Triangle chart from General Electric from the beginning of February to the middle of April. As you can see over the time period the stock price is generally rising from the low $24’s to $26. The breakout above $26 may have been a signal to go long in the stock.

 

The exact opposite is true for a descending triangle pattern. If you see the price of a company trending lower over a period of time it may help to analyze where that stock found support recently. Below you can see the support level for Ebay is about $19 a share which it hit at the beginning of April and then again in the middle of May. If the stock price falls below that support level it may be an indicator of a long term price decline on the way. Best to stay away from the stock and wait until it finds a lower support level and consolidates from there.

Descending Triangle - Ebay

This is a recent example of a Descending Triangle in the market. As you can see Ebay’s stock price is trending lower from the middle of March to the beginning of June. A break down below the support line around $19 might be a good indicator to sell.

Double Tops and Bottoms:

Double Tops and Bottoms are my favorite trend to look for whether I’m searching for a new position or selling a current holding. This chart is made up of three distinct features: a resistance level, a support level and the double top or bottom (or what I like to call the W or M). Take the stock chart of Walmart pictured below. Throughout January the price declines rapidly from $79 to an ending of ~$72 at the beginning of February. This is where the stock stops falling, aka, an initial support level. The stock then moves up to $76 creating a resistance level there and then drops back to the $72 range. Now admittedly, looking at the second chart, having the gumption to purchase here is no easy matter. There’s no way of knowing if the stock will go down or not from here. Chances are though that if the stock (as Walmart did) hit’s the support level for a second time and starts to trend up then you’re looking at a potential Double Bottom trend. As you can see with Walmart, the stock broke through the resistance at the end of March and traveled north to $80 a share in April. To be fair though, the stock price also could have easily jumped around in between the resistance and support lines creating a consolidation period for a period of days, weeks or months. 

Double bottom - Walmart

Walmart’s stock price from January to April of this year was a perfect example of a Double Bottom Chart.

What to do?

Buy or wait?

A Double Top chart on the other hand is a leading signal to sell. Take the chart below from Ford as an example. You can see the stock tops twice at $30 in 2000 and 2001, then breaks the resistance level of $20 a share in the third quarter of 2001. The orange line is then the eventual decline of the stock price to less than $10 a share during the Early 2000’s Recession.

Double Top - Ford (F)

Double Top – Ford (F)

Ideally though for simple investing it would be ideal to find a simple growth stock with an upward facing long term diagonal trend line. Such as the two below.

Disney (DIS)

Disney (DIS)

3M (MMM)

3M (MMM)

 

I hope you found this information useful. Please leave a comment if you have an idea for a future “Investing for Beginners” blog post. Lastly, always remember that just by starting an investment account you’re also creating an additional savings account for your future. Therefore, if you’re putting away even $100 a month that’s still helping to build up a nest egg for retirement or a first home purchase.

*Disclosure – This is not professional advice and investing can be risky business. Don’t assume you’re going to always make money, you will lose at some point. Never make an investment decision solely off something you read or hear. Make sure to do your own research before making investment decisions.

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One thought on “How to Invest – Part 1: Technical Investing

  1. Thanks, David! Your explanation of the various charts is especially helpful. Thanks taking the time to put it in laymen’s terms.

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