Technical Analysis Explained.

Types of Technical Analysis

Yield Curve

• The slope of the U.S. Treasury yield curve is a well-known predictor of economic cycles. An inverted yield curve (short-term rates higher than long-term rates) has historically signaled recessions and potential stock market downturns.

• Flattening/Inverted Yield Curve → Defensive sectors like consumer staples, healthcare, and utilities tend to outperform.
• Steepening Yield Curve → Cyclical sectors like financials, industrials, and materials benefit

Investment Strategy: Investors use yield curve signals to tilt portfolios toward sectors expected to perform best in different economic phases.

Inverted Yield Curve → Bear Markets: Historically, when the 10-year Treasury yield falls below the 2-year yield, recessions often follow within 12-18 months, leading to stock market downturns.

Steep Yield Curve → Bull Markets: A sharply rising yield curve often signals economic expansion, favoring cyclical sectors like financials and industrials.

Example: The 2000 and 2008 recessions were preceded by yield curve inversions, correctly signaling market corrections.

Momentum

• Relative Strength Index (RSI) – Measures whether a stock or index is overbought or oversold, helping traders anticipate reversals.   RSI (over 70 = overbought, below 30 = oversold) → Helps spot potential reversals.

RSI (Relative Strength Index) in Bull Markets: Stocks with RSI near 70 tend to stay         overbought longer in strong uptrends.

• RSI in Bear Markets: Values below 30 often signal deep oversold conditions—buying opportunities during sharp corrections.

Example: During the March 2020 COVID crash, major indices hit RSI levels below 20, signaling an oversold market right before a rapid recovery.

• Moving Average Convergence Divergence (MACD) – Tracks momentum shifts and potential trend reversals. Bullish crossover signals upward momentum; bearish crossover warns of declines.

Investment Strategy: Traders use RSI to time entries and exits, avoiding buying in overheated conditions or selling too soon in oversold markets.

Trend Indicators

• Simple Moving Average (SMA) – Helps identify long-term trends by smoothing out price fluctuations.
• 50-day and 200-day SMA Crossovers → Golden cross (bullish) and death cross (bearish) can indicate major trend shifts.

• Bollinger Bands – Measures volatility and potential breakout points. Expanding bands suggest high volatility, while contracting bands indicate consolidation.

Investment Strategy: Trend investors buy during golden cross formations, while contrarians short when stocks pierce the upper Bollinger Band.

  200-Day Moving Average: Historically, when an index crosses above its 200-day moving average, it confirms a trend reversal.

• Bollinger Bands Expansion → Volatility Surge: When bands widen sharply, volatility is about to increase—often due to earnings surprises or macro events.

Example: In Q4 2021, tech stocks breached upper Bollinger Bands, signaling extreme optimism—followed by a sharp correction in 2022.

Valuation-Based Indicators

• Shiller P/E Ratio (CAPE) – A long-term valuation metric that has historically signaled market bubbles and corrections.

• High CAPE (>30) → Indicates the market may be overvalued.
• Low CAPE (<15) → Suggests undervaluation and stronger future returns.
• ·  Historically, markets with CAPE ratios above 30 have underperformed in the following decade.

• ·  The CAPE ratio below 15 in past market downturns (e.g., 2009) signaled buying opportunities.

Example: Before the Dot-com crash (2000), the CAPE ratio exceeded 40, indicating severe overvaluation and predicting a sharp decline.

Investment Strategy: Value investors use CAPE to gauge whether long-term buy-and-hold strategies are attractive.

• Enhanced Value Ratios – Adjusted valuation metrics that incorporate macroeconomic factors.

Market Breadth & Sentiment

• Advance-Decline Line (AD Line) – Tracks market participation, helping confirm trends. Falling AD line while indexes rise suggests weak market participation.
• Advance-Decline Line Weakness → Market Tops: Major selloffs often begin when fewer stocks participate in uptrends.

• Fear & Greed Index – Measures investor sentiment, often signaling turning points. Excessive greed often signals market tops; fear can indicate bottoms.
• Excessive fear often precedes major rebounds, while excessive greed signals market tops.

Example: October 2022 saw extreme fear readings, coinciding with a market bottom and recovery into 2023.

Investment Strategy: Contrarian investors monitor sentiment to spot buying opportunities during fear-driven selloffs.

Applying Technical Indicators to Specific Sectors

Different technical indicators can help analyze sector movements, identify opportunities, and manage risk more effectively. Here's how they apply across key sectors:

Technology & Growth Stocks

Best Indicators:

• Momentum (RSI, MACD) → Tech stocks tend to exhibit strong momentum; overbought RSI above 70 can signal tops.
• Bollinger Bands → Expanding bands indicate breakout potential; contracting bands suggest consolidation before a move.
• Shiller CAPE Ratio → Helps assess long-term valuation risk in high-growth sectors.

Example: The Nasdaq-100 (NDX) peaked in late 2021 with RSI near 80, signaling extreme overbought conditions before the 2022 downturn.

Financials & Interest Rate-Sensitive Stocks

Best Indicators:

• Yield Curve Spread → A flattening/inverting yield curve often signals reduced profitability for banks.
• Volume & Breadth Metrics → Financial stocks respond well to institutional accumulation (money flow index).
• MACD Crossovers → Useful for identifying trend reversals.

Example: Bank stocks struggled in 2023–2024 as the yield curve inverted, reducing loan profitability.

Energy & Commodities

Best Indicators:

• Relative Strength vs. Broader Market → Tracks energy sector outperformance versus the S&P 500.
• Crude Oil & Natural Gas Price Trends → Key drivers for oil & gas stocks.
• Bollinger Bands & MACD → Useful for trading cyclical commodity stocks.

Example: Energy stocks surged in 2022, following oil price spikes; RSI confirmed strong upside momentum.

Defensive Sectors (Healthcare, Utilities, Consumer Staples)

Best Indicators:

• Fear & Greed Index → Defensive stocks thrive during high fear periods (market sell-offs).
• Dividend Yield vs. Treasury Yields → Investors rotate into defensive stocks when dividends exceed bond yields.
• Advance-Decline Line → Confirms sector strength despite broader market weakness.

Example: In 2020, healthcare stocks outperformed as investors sought stability amid pandemic fears.

Sector-Specific Screening Using Technical Indicators

To identify sector opportunities, investors often use a combination of trend, momentum, valuation, and sentiment indicators. Below is a sector-by-sector screening approach based on current market conditions:

Technology & Growth Stocks

Key Indicators:

• Momentum (RSI, MACD): Screens for strong uptrends and breakout potential.
• Earnings Growth & Forward P/E: Helps identify undervalued tech stocks relative to growth potential.
• Volatility (Bollinger Bands): Expansion signals increased trading activity.

Screening Example (Current Conditions):

• Focus on stocks with RSI between 50-70, indicating steady but not overheated momentum.
• Look for MACD bullish crossovers, signaling trend continuation.
• Check Forward P/E vs. historical average for valuation insights.

Financials & Banking Stocks

Key Indicators:

• Yield Curve Spread: Determines sector profitability based on rate differentials.
• Net Interest Margin (NIM): Measures banks' ability to profit from lending.
• Institutional Accumulation (Money Flow Index): Tracks big-money movement into financials.

Screening Example (Current Conditions):

• Banks with rising NIM and stable loan growth tend to perform well.
• Look for high institutional inflows (Money Flow Index above 50) to confirm confidence.
• Steepening yield curve favors banks with strong credit portfolios.

Energy & Commodities

Key Indicators:

• Relative Strength vs. Broader Market: Screens for energy outperformance.
• Commodity Price Trends: Oil and gas prices drive stock movements.
• MACD & Bollinger Bands: Useful for spotting sector breakouts.

Screening Example (Current Conditions):

• Crude oil price trends above moving averages signal bullish conditions.
• Energy stocks with RSI 55-65 show strong but stable upside momentum.
• Look for MACD crossovers above zero, confirming positive trend.

Defensive Sectors (Healthcare, Utilities, Consumer Staples)

Key Indicators:

• Investor Sentiment (Fear & Greed Index): Defensive stocks thrive in fear-driven markets.
• Dividend Yield vs. Treasury Yields: Helps assess sector rotation potential.
• Advance-Decline Line: Measures participation strength.

Screening Example (Current Conditions):

• Focus on high-yield dividend stocks where yields exceed Treasury rates.
• Defensive stocks with stable RSI (40-60) tend to outperform during downturns.
• Institutional buying in consumer staples signals rotation into safety.

Historical Case Studies

1. The 2008 Financial Crisis & Moving Averages

Indicator Used: 200-day Moving Average (SMA)

• In 2007, the S&P 500 experienced a death cross (50-day SMA crossing below the 200-day SMA), signaling a bearish trend.
• Investors who exited positions based on this signal avoided the worst of the 2008 crash.
• The golden cross in 2009 marked the beginning of the recovery.

Lesson: Moving averages help identify long-term trend reversals.

2. The Dot-Com Bubble & RSI

Indicator Used: Relative Strength Index (RSI)

• In 1999, tech stocks showed RSI levels above 80, indicating extreme overbought conditions.
• The Nasdaq-100 peaked in March 2000, followed by a sharp decline.
• Traders who monitored RSI exited before the crash, preserving capital.

Lesson: RSI helps spot overheated markets before corrections.

3. The COVID-19 Crash & Bollinger Bands

Indicator Used: Bollinger Bands

• In March 2020, the S&P 500 broke below its lower Bollinger Band, signaling extreme volatility.
• Investors who bought near this level benefited from the rapid recovery.
• The upper Bollinger Band breakout in late 2020 confirmed the bull market.

Lesson: Bollinger Bands help identify volatility extremes and potential reversals.

4. The 1987 Crash & Market Breadth

Indicator Used: Advance-Decline Line (AD Line)

• Before Black Monday (Oct 1987), the AD Line showed declining participation despite rising stock prices.
• This divergence signaled weakening market strength.
• Investors who acted on this signal avoided the sudden crash.

Lesson: Market breadth indicators reveal underlying weakness before major selloffs

There are many other forms of technical analysis not mentioned here, but these are the most popular ones. The key to using these indicators is moderation. In other words, don't buy or sell a position solely on the basis of one or two technical indicators. Instead, look into why the price of the asset is behaving the way it is before making a buy or sell decision.

Technical indicators can be a valuable tool when used in conjunction with fundamental analysis.