One of the things I am asked the most about is options income strategies. As a technician, my answer is always the same – you need to have a deep understanding of the technicals and the patience and discipline to analyze the charts.
At its core, technical analysis is simply interpreting behavioral patterns on a chart. The goal is to interpret the patterns correctly; if you do, you can expect them to occur again in the future. That’s because when it comes to money, human behavior does not change on the greed-fear spectrum. The charts depict this behavior quite clearly, and it’s up to us to interpret the behavior correctly. With technicals, experience is the best teacher.
As technical analysis has evolved over the years, it has expanded to include numerous elements of price/volume analysis. There are so many indicators and different views now that I could not even begin to name them all. Ironically, many of these indicators say the same thing, but the important point is to find the ones that work well for you. It then falls to you to become an expert at it.
One common misperception about technical analysis is that you use it to make predictions. You do not! Reading technicals and charts is about looking at the behavior of the public through the prism of a price/volume chart.
A great example of this occurred back in 2000, when the IBD (Investors Business Daily) flashed a major warning sign in March. This precluded the dot com implosion and the ensuing nasty bear market by about a month. Was this a prediction? No, the warning sign was based on evidence.
Prior to this call, IBD had been strongly bullish for months. So were many analysts, who were suddenly run over by a bulldozer. Obviously, one of their options income strategies was not technical in nature. Instead of focusing on the facts, analysts were making predictions based on a guess. (Yes, I know that company valuations were off-the-charts insane, but that condition existed for many months before the stock market finally caved.)
Technical analysis is an art and a science. Much like viewing a painting, two people can have diverging views of what is happening. This is where experience comes into the picture. We begin to analyze patterns, trends, and behavior on a chart based on our experiences. We use various calculations based on prices (high, low, open and close) and study moving averages to find the best trends. Again, interpretation, history and experience are key in drawing conclusions.
Want to become a great technician? Find and use the indicators that work well for you. Look at past factual data and make an interpretation based on the evidence. As long as investors and traders are fearful about losing money or greedy about making more money, then you can feel confident that the patterns you see on the charts will continue to appear over and over again.