Does Technical Analysis Actually Work On Small-Cap Stocks?
James Woolley
April 05, 2009
Technical analysis is used by a lot of investors to look for potential companies to invest in to begin with, and then for timing entry and exit points. However is it such an effective tool when investing in small-cap stocks?
Well in my opinion technical analysis unquestionably works best when it is applied to mid and large-cap stocks. This is because they are much more widely traded and so any patterns that emerge on their respective charts are often spotted and acted upon by lots of other traders as well.
Plus there is also the fact that these stocks are often stuck in established trading ranges for long periods of time, so it's very easy to use technical analysis to find overbought and oversold set-ups within these trading ranges. The resulting price moves are often predictable and therefore profitable to trade, and in a way become self-fulfilling because many other investors will buy at the same kind of levels where there is historical support, and sell at established resistance levels.
This is not the case for smaller stocks, however. While the share prices of the larger companies move broadly in line with the wider market and conform very well to technical analysis, smaller stocks are primarily driven by company-specific news and speculation.
Therefore applying technical analysis to these stocks can be a fruitless exercise. For instance if you spot a company that is looking oversold according to a number of different indicators, ordinarily this may be worth considering, but with smaller companies there is always a chance that a company is temporarily oversold because the company is in real financial trouble. Therefore their share price may fall even further (and possibly all the way to 0 if they go bankrupt), so this is a risk you face when investing in small-cap stocks that are oversold.
Technical analysis is not a very useful for exiting positions either because if you sell when indicators such as RSI and stochastics reach overbought levels, then you may miss out on a lot of gains because small-cap stocks can jump in price very quickly regardless of what various indicators may say.
So while it may be worth casually looking at your preferred technical indicators when investing in small-cap stocks, in general it's company-specific news that you should pay most attention to. This is what ultimately drives the share price of these smaller companies.
Click here to read all the latest online trading news and to read a full Options University review.
Well in my opinion technical analysis unquestionably works best when it is applied to mid and large-cap stocks. This is because they are much more widely traded and so any patterns that emerge on their respective charts are often spotted and acted upon by lots of other traders as well.
Plus there is also the fact that these stocks are often stuck in established trading ranges for long periods of time, so it's very easy to use technical analysis to find overbought and oversold set-ups within these trading ranges. The resulting price moves are often predictable and therefore profitable to trade, and in a way become self-fulfilling because many other investors will buy at the same kind of levels where there is historical support, and sell at established resistance levels.
This is not the case for smaller stocks, however. While the share prices of the larger companies move broadly in line with the wider market and conform very well to technical analysis, smaller stocks are primarily driven by company-specific news and speculation.
Therefore applying technical analysis to these stocks can be a fruitless exercise. For instance if you spot a company that is looking oversold according to a number of different indicators, ordinarily this may be worth considering, but with smaller companies there is always a chance that a company is temporarily oversold because the company is in real financial trouble. Therefore their share price may fall even further (and possibly all the way to 0 if they go bankrupt), so this is a risk you face when investing in small-cap stocks that are oversold.
Technical analysis is not a very useful for exiting positions either because if you sell when indicators such as RSI and stochastics reach overbought levels, then you may miss out on a lot of gains because small-cap stocks can jump in price very quickly regardless of what various indicators may say.
So while it may be worth casually looking at your preferred technical indicators when investing in small-cap stocks, in general it's company-specific news that you should pay most attention to. This is what ultimately drives the share price of these smaller companies.
Click here to read all the latest online trading news and to read a full Options University review.
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