Add Some 'Magic' to Your Investing Tool Kit

Editor's note: This weekend, we're taking a break from our usual fare to share a Masters Series essay on how technical analysis can benefit you – whether you're a new or seasoned investor. Used by Greg Diamond in his Ten Stock Trader advisory, this approach shows you how to recognize price moves and metrics to understand what's really happening in the markets.

It was just another ho-hum day in 2020...

That morning's headlines...

U.S. sees single-day record of COVID-19 deaths.

All states certify election results.

Facebook facing a breakup?

Congress still negotiating more stimulus.

FDA panel to meet to discuss Pfizer COVID-19 vaccine.

And that was all before 9 a.m.

In any case, it was the type of day that makes me thankful... No, not for my relative health, or for having a job and plenty of things to write about.

I am thankful for those things. But when it came to the market, this barrage of morning news reminded me that I'm thankful... for technical analysis. Allow me to explain briefly...

Technical analysis is a brand of stock analysis that doesn't care about the headlines. It doesn't even care about companies, in a sense... and certainly not anywhere close to the way fundamental analysis grades worthy investments.

The main focus of technical analysis is price, which sounded refreshing to me the first time I heard about it. As Ten Stock Trader analyst Greg Diamond, who uses this strategy, wrote in DailyWealth in December...

Technical analysis focuses on price behavior of a stock or asset through various indicators and price patterns.

As my boss said... "Technical analysis focuses on now, fundamentals on what was."

You might think of technical analysis as "chart reading." But as Greg wrote in last Saturday's Weekend Edition, it's more than that. It's looking beyond trendlines and patterns to understand the behavior of people in the market.

Looking at price also means learning from history and human nature.

This concept isn't necessarily the easiest to grasp or believe, and it might not be for everyone. Until you really practice it and understand it, a lot of this can sound vague or mystical... or like we're talking about magic... And frankly, it might feel that way in today's essay, too.

But once you understand the details – by following experts like Greg or DailyWealth Trader editors Ben Morris and Drew McConnell, who also use technical analysis extensively – it can be a breakthrough for a lot of investors.

Technical analysis can't identify great, high-quality companies. To do that, it takes good fundamental research, understanding balance sheets, and knowing what business qualities matter most.

Technical analysis also won't tell you, at least directly, about the warts of the financial system... though it will reveal just how distorted things have gotten by showing how much influence the Federal Reserve has.

Rather, it's about things like "oversold" and "overbought" metrics, "moving averages," and "support" and "resistance" lines that mark key points of supply and demand. It's about what the picture looks like now. And trust me, that's just the start...

Greg discussed "price divergence" as another example last Saturday...

I look for price divergence across major indexes. This is a common focus in my weekly updates and in my live feed. When one index makes a new cycle low (or high) while another doesn't, this creates divergence.

That's usually a sign of a reversal on the horizon. It can be tricky to spot this pattern, but it's a valuable analysis to understand. A massive divergence occurred just before the crash in February 2020. Take a look...

Notice the divergence between the Dow Jones Transportation Average in black and the Dow Jones Industrial Average in blue. The green circles marked a lower high in the Transports' price, while the black circles marked a higher high in the Industrials' price... setting up the divergence.

Obviously, this is an extreme example considering the massive crash that happened in the markets because of COVID-19. But such a big divergence provided a big warning that something was wrong – the two indexes were not in sync.

Indicators like these can't predict with certainty what's going to happen on any given day, but they can narrow the range of possibilities you may want to prepare for.

And it works particularly well at big turning points, too. When everyone else is going crazy, the numbers don't lie.

Technical analysis, which is really a school of thought, helped guide us through March 2020's crash and ultimate bottom... and then through the market rebound afterward. Certain indicators told us the broader U.S. indexes were likely heading up, up, up again...

A peak in "breadth" – which is what we're seeing now – has traditionally been a big bullish technical indicator for stocks over the next year or two. That's what it's called when a lot of stocks are moving higher, not just the market leaders.

During the dot-com boom, breadth peaked in early 1998... The stock market peaked in 2000.

More recently, breadth surged in 2013... then the benchmark S&P 500 Index rallied 45% before peaking in 2015. And in 2016, breadth surged again... and stocks went up another 35% into 2018.

And of course, human nature applies to all asset classes...

That's how Greg, Ben, and Drew can write about it every trading day. Here's just one example... Ben and Drew sent this analysis to their DailyWealth Trader subscribers in December as part of their updated instructions for an open trade...

An asset often builds up energy by trading sideways for an extended period of time. Then, it breaks out of its trading range and releases that pent-up energy.

When this happens, the asset tends to continue moving in the same direction of the breakout (higher) or breakdown (lower). And if you get on board, you can earn fantastic profits.

And second, when an asset's shorter- and longer-term moving averages start to move in the same direction – with the shorter-term moving average on top of the longer-term moving average – it's a good sign that the asset is ready to move in that direction.

Our point is... if you're interested in short-term trading, technical analysis – think the trading equivalent of the sports analytics described in Michael Lewis' bestselling book Moneyball – is a must-know, as far as we're concerned.

And even if you're a long-term investor, it's worth considering how you can use technical analysis in your approach. It can help you figure out what big moves might be coming.

As Greg often describes so well, technical analysis can help you do this in advance. The biggest point is that these tools allow you to prepare and bet with defined risk and reward targets.

We'd rather do this than buy or sell the "news."

The best advice I can give you is this... Give technical analysis a try, or at least give it a good look, and see where it takes your portfolio.

Good investing,

Corey McLaughlin

Editor's note: Greg predicts May 10 will mark a huge turning point in the market. What happens then could make or break your portfolio for this year – and beyond. It could even make you more money than you might have made over the course of the entire decadelong bull market. To get the details on what Greg sees on the horizon, click here to watch his presentation.