Understanding
Stock Options Trading
and Technical Analysis Basics

Technical Analysis Trends

Generally, when investors are deciding which options or stocks to buy, they will need to analyze the stocks to see whether they're worth buying. There are 2 methods of analyzing stocks, technical analysis and fundamental analysis (following hot tips from your neighbor doesn't count, unless your neighbor happens to be a Mr. Buffett).

Fundamental analysis involves researching to see if the market in general, as well as the stock in particular, is currently undervalued or overpriced. The fundamental analyst does so by comparing the current stock price with what they think is the fair value.

To gauge a stock's fair value, the fundamental analyst will look at the "basics" of a company. He will check the company's management practice, cash flow, total assets, earnings and revenue, debt, paid-up capital and so forth, to determine exactly how much the company's stock should be worth.

Once he has that value, he will compare it with the current stock price. If the stock price is cheaper than his estimation of its fair value, he will conclude that the stock is undervalued and worth buying.

That's fundamental analysis in a nutshell. For a more complete description, you can read TheStreet.com's article.


On the other hand, Technical Analysis involves trying to predict a stock's price movement by looking at how it has previously performed, and how people might act in the future. To a Technical Analyst, a stock price's past movement tells a lot about how it will move in the future.

A Technical Analyst doesn't care what a stock is really worth. Instead, he cares whether the public will buy the stock or not. He will use various charts and indicators (which we will discuss in the following pages) to monitor the trend and momentum of a stock as well as investors' behavior.

If a stock is on a roll and investors appear greedy, the technical analyst will probably decide that the price will continue to rise, and will invest in the stock. On the other hand, if the stock is losing steam, the technical analyst will probably conclude that investors are starting to lose interest in the stock, and he will avoid buying it since the price trend might reverse.

Easy-speak Fundamental Analysis attempts to uncover undervalued or overpriced stocks. Technical Analysis attempts to read the trend and momentum of a stock to determine if the trend will continue or reverse.

So which method is better? There are pros and cons to both methods, and both are utilized in the market. However, when we're dealing with options, the preferred method is using Technical Analysis trends.

Fundamental Analysis tends to deal with annual reports and quarterly forecasts, and to predict the steady growth of a stock. When we're working with stock options, "annual" and "quarterly" timeframes are just too long.

In option trading, the options we buy or sell usually have timeframes measured in weeks or months, and we do not have the luxury of waiting for a company's next annual report to confirm our move.

On the other hand, since Technical Analysis trends work to predict trends and momentum in stock prices, it is better suited to analyze short-term movement in stock prices. These momentum indicators can be used to show short-term trends, even to the extent of 5-minute intervals.

Easy-speak Technical Analysis is better able to predict short-term price movement, and is therefore more suitable for option-trading, where timeframes are measured in weeks, rather than years.

However, be warned that neither method (Fundamental or Technical) is 100% accurate in predicting a stock's movement, long-term or short-term.

Stock and market levels are easily affected by external forces such as global terrorism, oil prices, inflation and political change, as well as news that is directly related to the stock in question.

Therefore, caution must always be used when trying to predict a stock's movement, whichever method you choose to utilize.


Guide Index Technical Indicators

Other Topics in this Guide

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