Last time we used price chart of KCB to illustrate the fact that you do not have to lose sleep over price fluctuations but that you can in fact make money with proper advice.
We will now look at other indicators to use as an investor who should be positioned in the best sectors to take advantage of the best profits that can be offered.
These indicators are: The Relative Strength Index (RSI) and the Moving Average Convergence – Divergence (MACD). Please note that analysts use a variety of approaches to identify the best entry and exit points. We looked at how the price can guide us in making profitable trades and now we will look at how RSI and MACD can help us to confirm price movement and to decide whether to buy or sell shares in order to make money and avoid losses.
The Relative Strength Index (RSI) is one of popular indicators which helps signal to the trader whether or not the price of a share is due to those over-buying or over-selling it. RSI works on a scale of 0-100.
The standard scale for oversold or overbought is over 70 overbought while readings below 30 are oversold.
The Moving Average Convergence-Divergence (MACD) is another most used indicators in technical analysis. The standard MACD values used in the calculation are the 26-day and 12-day exponential moving averages. The signal line is created by using a 9-day exponential moving average. Therefore the common MACD settings are 12 26 9.
These indicators can be constructed manually but these days there are soft wares that are used to construct them. There are also a number of websites that provide free charts.
Let us use the Google Inc. chart to illustrate RSI and MACD indicators. Google trades at NASDAQ Exchange.
The MACD line – blue line (the difference between a 12 and 26 day moving averages).
Signal line – a 9 period moving average. See the red line
Centre or zero line. See the black line.
So how do we make, buy or sell decisions using RSI & MADC in order to make money?
As a general rule when RSI is above 70 line, it shows that the stock or market is at overbought levels. It warns us in advance that the stock may be over bought and may soon decline. Over bought does not mean over sold do not sell the moment you see RSI at above 70 line. It may remain there for an extended period of time. Remember also that if you are a long term investor, you do not have to react to these indicators until you have achieved your long term objective. It is not the time to take entry positions.
When RSI is below 30, it demonstrates that the market is oversold. It is a warning that the stock price has been unreasonably pushed down and may be on the way up. It is not the time to sell your stock but it is time to buy.
Using the Google graph above see that around end of June 2011, RSI was below 30 line almost approaching 20 line signifying that Google price had been pushed down unnecessarily and will soon turn. Notice that in July 2011 the RSI crossed above the 50 line (which indicates a bull market – investors are confident, prices are rising). RSI went below the 50 line in August 2011 signaling a bear market (generally pessimistic, negative market sentiments).
See how using this chart you can make a lot of money several times over in just one company if you know the best entry and exit positions.
The MADC indicator combines a moving average crossover system with the overbought/oversold elements of RSI. In other words the moving averages help analyst to identify subtle changes in the strength and direction of a stock’s trend and suggesting whether to buy or sell.
Buy signal are given when the MACD line (the blue line, 12, 26) crosses above the signal line (the red line 9) and both lines are below zero (black line). Sell signals are given when the MACD line crosses below the signal line from above the zero line (centre line, black line).
Note that when MACD line crosses over the zero line, it is a sign of optimism and investor confidence (bullish momentum). The reverse would signal bearish momentum – pessimistic attitude and negative market sentiments which drive the prices of a stock down.
Again using the Google graph you can see that towards the last week of June 2011 the MACD line (12, 26) crossed over the signal line (9) showing a buy indication of the Google share. Notice also that in July 2011, the MACD crossed also the zero line showing a bullish sentiment rising but crossed below the signal line during the first week of August 2011 giving a sell signal.
See also that this month (April 2012) MACD is about to cross below the signal line from above the zero line. Although the RSI is still above 50 line, it is showing a downward trend indicating it is not the time to be bullish.
I have avoided discussing price indicator in the Google chart because we discussed this in the last article using KCB graph. But notice that the price action could have given you the same sell or buy decision.
I have to repeat that if you are a long term investor these fluctuations do not mean much. For example, Google share prices dropped to around $ 250 in 2008 and now Google price is trading above $ 600. If you had sold at $ 250 due to fear you would have lost a lot of money. But consider how much you would make if you bought at $ 250 in 2008 and selling today when Google share is at $ 632. See the graph above.
I hope this has helped you understand how to make money and avoid taking decisions that would result in losses. It has probably now become obvious to you that one’s loss becomes another person’s gain while trading at the stock markets.
If you understand what you are doing or with the help of a professional advisor, capital markets provide huge opportunities to become a wealthy person.