The Dow can close at a record on a day when most stocks on the exchange close lower. A technical analyst reads that mismatch as a warning, and the Series 7 expects you to explain why.
Fundamental analysts study a company's earnings and balance sheet. Technical analysis studies the market itself: prices, trading volume and investor behavior. It assumes that supply and demand show up in price and volume before the reasons become obvious. Clients hear these signals on financial news and in your firm's morning notes, and they will ask you what the signals mean. The tools fall into four groups: market sentiment indicators, breadth and momentum measures, market indexes, and chart readings built from trend lines, averages and momentum.
Sentiment is how fearful or confident investors feel. You can't poll every investor, so analysts infer mood from what traders actually pay for.
Puts versus calls. A put gains value when a stock falls, and a call gains value when it rises. The put/call ratio divides the day's put volume by its call volume.
Common mistakes
- Calling fear a sell signal: A put/call ratio that jumps from 0.55 to 1.20, a VIX at 32 or heavy short interest shows a fearful crowd. When the question asks for the contrarian view, the answer is bullish.
- Counting borrowed money as buying power: The $1.48 trillion of margin debit balances is already invested. Only money market fund cash and free credit balances count as funds available to buy stocks.
- Treating the Dow like the S&P 500: In the price-weighted DJIA, a $400 stock outweighs a $40 stock no matter how large the companies are. The S&P 500 and Nasdaq Composite weight by market value.
Bottom line
- The put/call ratio is put volume divided by call volume, and days to cover (the short interest ratio) is short interest divided by average daily volume.
- Sentiment extremes are read as contrarian signals: a high put/call ratio, a high VIX or high short interest is bullish, and low readings are bearish.
- Breadth confirms a rally when advancers outnumber decliners, and an index at new highs with a falling advance/decline line is a bearish divergence.
- Money market fund cash and free credit balances in cash and margin accounts are funds available to buy stocks, while margin debit balances are not.
Exam shortcut
When a question names a sentiment indicator, first decide whether it wants the crowd's mood or the analyst's signal. Words like "contrarian" or "technical analyst" usually mean you should reverse the plain reading, so heavy put buying becomes bullish. For any chart pattern, look at where its middle sits: bottoms predict rises and tops predict declines, whatever the word "inverted" suggests.
The full lesson (about 4,655 words, 31 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C29
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