Chart Your Way to Easy Street!

Do you like working? Do you like making easy, easy money? What if I told you there was a way to use simple stock charting techniques to trade your way to financial freedom? Is that something you might be interested in? Well, here are my 31 easy steps to blowing the market out of the water using charts!

Come on, now, do you think I'd be writing this article if I really had those 31 steps? I can tell you for sure that if I had those 31 steps, I'd either be 1) using those stock charting techniques to make millions, or 2) enjoying the millions I made with my charting techniques by sipping daiquiris on the island of Mustique with the likes of David Bowie and Mick Jagger. But that's neither here nor there, since I'm not making millions trading on a chart system.

What I can tell you, though, is that if you do a Google search for "charting," you'll find more results than you know what to do with -- 30,200,000 to be exact. There are a lot of sites that let you build charts, some that give free introductions to charting, and plenty that are selling software, systems, and courses designed to help you see those price candles for what they really are: dollar signs. Whole brokerages have been established around the idea of providing the best charting tools, and even the tried-and-true old boys of online trading have beefed up the capabilities of their charts.

The Dow of TA
Charting, also known as technical analysis or TA, is the study of stock prices and how they move. TA actually grew out of something called Dow Theory, which was the brainchild of Charles Dow, the first editor of The Wall Street Journal. Dow posed six basic tenets of equity markets:

  1. Markets have three trends.
  2. Trends have three phases.
  3. The stock market discounts all news.
  4. Stock market averages must confirm each other.
  5. Trends are confirmed by volume.
  6. Trends exist until definitive signals prove that they have ended.

Somehow, these six statements today have created RSI, head and shoulders, MFI, resistance points, MACD, bear pennants, bull flags, slow stochastics, fast stochastics, and any of a thousand other technical indicators. By using these indicators and price patterns, technical analysts are supposed to be able to figure out which direction a price is going to move and make a tidy profit in the process.

Why so much fuss over technical analysis? Well, it's fast, it's sexy, and you can make or lose a whole lot of money really fast. Come to think of it -- it sounds vaguely like something else. Wait, give me a second . Oh, yeah, gambling.

Survey says!
Thousands of investors surveyed, top three answers up on the board. The question: GE (NYSE: GE  ) -- buy, sell, or hold?

SELL!

Survey says: Ding! An overwhelming majority of investors say that GE is a sell. Wait, no, buy. No, sell. Hold on, hold. Yeah, hold. No, BUY!...

In large part, technical analysis involves trying to predict the sentiment of the vast sea of other investors and whether they are buying and selling a given stock. So, for instance, if I'm following a chart of AMD (NYSE: AMD  ) and see the price begin to turn up and that turn is supported by whatever technical indicator I'm watching, then I'm hopping on the AMD train. Now, just in case it's not really rally time, I'd put a stop order to sell under my AMD purchase in case I'm wrong. That way, if AMD goes down instead of up as my technical indicators told me, it automatically sells before I lose too much money. On the other hand, if AMD does go up, I can either do a quick sell and take my small profit or push up my stop to protect the paper profit that I now have while hoping the stock continues to rise. Follow so far? If so, don't worry. These are just the basics.

Since TA is not quite an exact science, part of the TA trader's mantra is being able to take losses quickly so they don't get out of control. So, the trick is that if I can keep my profits above my losses either by having more small winners than small losers or by having a few big winners to offset a lot of small losers, then I get rich, right?

Well, it's not exactly that simple. First of all, the track record of being able to predict price movements based on prior price movements or chart formations is spotty at best. Additionally, technical traders moving on trends have to first see that a trend is there, so they're not in the move on the ground floor, and then they either have to make a decision to sell when the trend is still alive and moving or wait for a definite end when the price has come back down a bit. Combine the two, and you're chopping a nice bit out of the potential profit you have from a given move. And what do you have left? Well, if you do have something left at this point, don't forget the commissions you're paying on the way in and the way out. Speaking of which, brokers love day traders.

Forget the voting machine
If you're a fan of Ben Graham, the granddaddy of value investing and fundamental analysis, you're probably familiar with his idea that "in the short run the stock market acts like a voting machine, but in the long run it acts as a weighing machine." So while the TA fellows are trying to predict the results from the voting machine, the rest of us Fools are busy weighing the stocks that they're voting on and patiently waiting for the market to validate our measurements.

So, why should a Fool skip the quick money of TA for the "measured approach" of Graham and Buffett? Well, say I take my cynical cap (which rarely leaves my head) off and concede that some consistent profit, if not a decent amount of profit, can be made using technical analysis. Even with that concession, I would point out that investor sentiment has a tendency to turn on a dime, so TA practitioners need to be on top of every move the market makes. This means watching every tick of the tape through the seven hours that the market is open, for fear of leaving a trade on too long and getting taken to the cleaners, or missing the one great trade that would have made your day -- or your year. Sound like a full-time job? It is.

So, for the "rest of us" who have day jobs and can't spend seven hours of the eight-hour work day staring at stock charts, there is fortunately the alternative of fundamental analysis. This, of course, is the fabulous method of building long-term wealth in the stock market by finding great companies whose stock is selling at a good value. This is also the type of investing that led famed Wharton professor Jeremy Siegel to say that in the long run, stocks are the numero uno, top-dog asset class for investors.

Can a Fool be a fool?
For the Fool who wants to fool around a bit, is it a cardinal sin to toy around with a little technical analysis? I'd say no way. I enjoy going to Vegas as much as the next guy, and when I do, I'm sure to bring some money for gambling and some money for lodging and eating. I gamble with the gambling money and feed myself with the other stash, but the money I come to gamble with is always money I can afford to lose.

So, if you like the excitement and action of trying to guess the next move of a stock, by all means go for it, but a Foolish move would be to do it with money that you can absolutely stand to lose. And if you do happen to get rich off your technical trading, be sure to tell Mick I said, "Hiya."

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Fool contributor Matt Koppenheffer does not own any of the stocks mentioned in this article, but he is considering a short position on GE based on a developing inverted Orion pattern in the GE chart. (Or is it a sideways Leo Minor with Gemini features?) The Motley Fool's disclosure policy is never a gamble.


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