Technical analysis is often shrouded in myths and misconceptions. Many analysts overcomplicate the process, while others rely on dubious methods that are more science fiction than legitimate market analysis. But when understood and applied correctly, technical analysis can be a powerful tool for identifying market trends and making informed investment decisions. It’s all about studying price levels, trends, momentum, and the underlying psychology of the market.
Take McDonald’s Corporation (MCD) for example. Despite its recent earnings report, the company’s stock chart reveals valuable insights into its current trajectory. This is why our team of technical analysts has chosen McDonald’s as our Stock of the Day.
One key concept in technical analysis is the idea of ‘overbought.’ This refers to a stock’s momentum, or how much it has moved in a given period. Typically, a stock trades within a normal range. However, if buyers become overly enthusiastic and push the price significantly above this range, it can trigger a selloff. This is because sellers may anticipate a return to the average price, or a ‘reversion to the mean.’ Their selling pressure can then lead to a downward trend, creating a self-fulfilling prophecy.
The lower part of the chart displays the Relative Strength Index (RSI) momentum indicator. A reading above the horizontal red line indicates overbought conditions. As you can see, McDonald’s stock exhibited this pattern just before its recent decline.
Another important aspect of technical analysis is the identification of key price levels. The chart clearly shows the significance of the $292 level. In August, it acted as resistance, preventing the stock from rising further. Now, however, it has become a support level, potentially indicating a floor for the stock price.
This shift from resistance to support is a fascinating example of investor and trader psychology. When a stock hits a resistance level, some investors may sell, only to regret their decision later when the price rises. These remorseful sellers might try to buy their shares back at the same price they sold them for. If enough investors do this, it can create a support level at the same price that was previously resistance. This is precisely what seems to have happened at the $292 level for McDonald’s.
The best traders don’t overthink things. They focus on important levels, trends, and momentum. This common-sense approach, grounded in technical analysis, can be a key to profitable investing. By understanding these dynamics, investors can make more informed decisions about when to buy, sell, or hold their investments.
