One analyst reads a stock's chart and says the timing is wrong. Another reads its financial statements and says the price is wrong. The exam tests whether you know which question each method answers.
A client can ask you two questions about a stock. Is it worth owning? Is now the time to buy? One family of methods answers only the second question.
Technical analysis forecasts price moves from past prices, trading volume and other market data. It rests on the view that supply and demand show up as trends and patterns that repeat. If buyers have stepped in at $40 three times, a technician expects them to step in there again. The technician works without studying the company's finances. There is no earnings estimate, no balance sheet review and no valuation. Because the method says nothing about what a business is worth, it is used mainly to time purchases and sales.
Each chart pattern shows whether buyers or sellers are in control.
Common mistakes
- Plugging in this year's dividend: Using in Example 1 gives 2.00 ÷ 0.05 = $40.00 instead of $41.60. Always grow the dividend one year first.
- Reading contrarian signals literally: A high put-call ratio, heavy odd-lot selling and high short interest are all bullish readings.
- Flipping chart signals: Support is the floor and resistance is the ceiling. A head-and-shoulders top is bearish, and only the inverted bottom is bullish.
Bottom line
- Technical analysis times purchases and sales using past prices, volume and market data, and it never uses the company's finances.
- Support is a floor, resistance is a ceiling, and heavy volume confirms a breakout through either one.
- A golden cross and an inverted head-and-shoulders bottom are bullish, while a head-and-shoulders top is bearish.
- High short interest, a high put-call ratio and heavy odd-lot selling are all bullish contrarian readings.
Exam shortcut
Sort the question stem first. Chart, volume or timing language means technical analysis. Earnings, management or worth means fundamental analysis. For any indicator built on crowd behavior, flip the obvious reading before you answer. On a Gordon question, check whether the dividend was just paid. If it was, multiply by (1 + g) first. Before calculating, confirm that r exceeds g and that the company pays a dividend.
The full lesson (about 3,406 words, 23 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- B10
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