Candle Stick Charting

Candlestick charts have been around for hundreds of years. They are often referred to as "Japanese Candles" because the Japanese would use them to analyze the price of rice contracts.Similar to a bar chart, candlestick charts also display the open, close, daily high, and daily low. A difference is the use of color to show if the stock was up or down over the Candlestick charts have a "love or leave" relationship with investors. People either love candlesticks and use them frequently, or are completely turned off by them. There are several patterns people look for with candlestick charts, here are a few of the popular ones and what they mean:

This is a bullish pattern, the stock opened at (or near) its low and closed near its high.

The opposite of the pattern above, this is a bearish pattern. This indicates that the stock opened at (or near) its high and dropped substantially to close near its low.

Called "The Hammer", this is a bullish pattern only if it occurs after the stock price has dropped for several days. A Hammer is identified by a small body along with a large range. The theory is that this pattern can indicate a reversal in the downtrend is in the works.

Called a "star". This pattern is used in others such as the "doji star".For the most part, stars typically indicate a reversal and or indecision.There is the possibility that after seeing a star there will be a reversal or change in the current trend.

Using the Moving Average

One of the easiest indicators to understand, the moving average shows the average value of a security's price over a period of time. To find the 50-day moving average, you would add up the closing prices (but not always, we'll explain later) from the past 50 days and divide them by 50. Because prices are constantly changing, the moving average will move as well. It should also be noted that moving averages are most often used when compared or used in conjunction with other indicators such as MACD and EMA.

    The most commonly used moving averages are of 20, 30, 50, 100, and 200 days. Each moving average provides a different interpretation on what the stock will do, there is not one right time frame. The longer the time span, the less sensitive the moving average will be to daily price changes. Moving averages are used to emphasize the direction of a trend and smooth out price and volume fluctuations (or "noise") that can confuse interpretation.

Here is a visual example using the stock price of AT&T:

Notice back in September when the stock price dropped well below its 50-day average (the green line). There has been a steady downward trend since then and no real strong divergence, until the end of December where it rose above its 50-day average and continued to rise for several weeks.
Typically, when a stock price moves below its moving average it is a bad sign because the stock is moving on a negative trend. The opposite is true for stocks that protrude their moving average - in this case, hold on for the ride.

Using the Relative Strength Index

When talking about the strength of a stock there are a few different interpretations, one of which is the Relative Strength Index (RSI). The RSI is a comparison between the days that a stock finishes up against the days it finishes down. This indicator is a big tool in momentum trading. The RSI is a reasonably simple model that anyone can use. It is calculated with the following formula. (Don't worry, most likely, you will never have to do this manually).

RSI = 100 - [100/(1 + RS)]
where:
RS = (Avg. of n-day up closes)/(Avg. of n-day down closes)
n= days (most analysts use 9 - 15 day RSI)

The RSI ranges from 0 to 100. A stock is considered overbought around the 70 level and you should consider selling. This number is not written in stone, in a bull market some believe that 80 is a better level to indicate an overbought stock since stocks often trade at higher valuations during bull markets. Likewise, if the RSI approaches 30 a stock is considered oversold and you should consider buying. Again, make the adjustment to 20 in a bear market.
The shorter number of days used, the more volatile the RSI is and the more often it will hit extremes. A longer term RSI is more rolling, fluctuating a lot less. Different sectors and industries have varying threshold levels when it comes to the RSI. Stocks in some industries will go as high as 75-80 before dropping back and others have a tough time breaking past 70. A good rule is to watch the RSI over the long term (1 year or more) to determine what level the historical RSI has traded at and how the stock reacted when it reached those levels.

Here, we have an RSI chart for AT&T. The RSI is the green line, its scale is the numbers on the right hand side that go from 0 to 100. Notice the RSI was approaching the 60-70 levels in December and January and then the stock (blue line)
sold off. Also, notice around October when the RSI dropped to 25 the stock climbed up nearly 30% in just a couple weeks.
Using the moving averages, trend lines, divergence, support, and resistance lines along with the RSI chart can be very useful. Rising bottoms on the RSI chart can produce the same positive trend results as it would on the stock chart. Should the general trend of the stock price tangent from the RSI, it might spark a warning, the stock is either over/under bought. The RSI is a great little indicator that can help you make some serious money. Beware that big surges and drops in stocks will dramatically affect the RSI, resulting in false buy or sell signals. Most investors agree that the RSI is most effective in "backing up" or increasing confidence before making an investment decision, don't invest simply based on the RSI numbers.