How to apply technical indicators to mutual funds

Most investors evaluate mutual funds using the principles of fundamental rather than technical analysis. Mutual funds tend to be long-term, buy-and-hold investments, and technical analysis is better suited for shorter-term trading.

That said, investors should not overlook the value of some common technical indicators in providing trading insights for almost any type of investment or financial instrument, including mutual funds. Below are five common technical indicators that can be applied to mutual funds.

1. Trend lines

Most technical analysis begins with trend lines, which are lines that connect various price points and extend into the future to identify price trends and areas of support/resistance. For mutual funds, look at a long-term price chart to determine its trend.

A trend line can be plotted by drawing a line connecting several lows of a mutual fund over time. The fund may have tested this trendline on numerous occasions over the years. If the fund price decisively breaks through a well-established, long-term trend line, this is a bearish signal. An investor in such a fund should consider selling their fund holdings if this happens.

Conversely, a breakout above a well-defined trendline can be a bullish signal, indicating that the investor should stay in the fund.

2. Moving averages

Moving averages are averages of time series data, such as prices. Investors can use it to identify price trends of a mutual fund. A rising moving average indicates that the fund is in an uptrend, while a falling moving average would indicate that it is in a downtrend.

A second major application arises from the crossing of two moving averages, for example a short-term, 20-day moving average and a long-term, 200-day moving average.

If the 20-day moving average breaks above the 200-day moving average, it will be considered as a bullish signal for the mutual fund. Conversely, if the 20-day moving average breaks below the 200-day moving average, it will be a bearish signal.

The 200-day moving average is considered an important technical indicator, with breaks above or below considered important trading signals. It is particularly suitable for mutual fund technical analysis due to its longer term nature.

3. Relative Strength Index (RSI)

The relative strength index (RSI) is a momentum indicator that compares the magnitude of recent gains to recent losses to evaluate whether the mutual fund is overbought or oversold.

An RSI above 70 would suggest that the mutual fund is overbought and overvalued and ready to pull back. An RSI below 30 indicates an oversold state that could trigger a bounce, which could strengthen a value investor’s buying decision.

4. Support and Resistance

A support level is formed when a mutual fund trades up to a certain level and then bounces back. Over time, this level becomes an area of ​​strong support for the mutual fund. Conversely, a resistance area is formed when the fund cannot break above a certain price level.

The further apart these tests of support and resistance are, and the more frequently the fund trades down or up to the support or resistance level, the more formidable they become. A break in long-term support is very bearish and could signal significant downside for the mutual fund. A move above long-term resistance is very bullish and indicates significant upside.

5. Chart formations

There are a number of different chart types used in technical analysis, with the most common being line charts and bar charts.

Advanced users may prefer candlestick charts to dot-and-figure charts. Chart formations for a mutual fund can be interpreted like stocks. For example, the head and shoulders pattern is interpreted as quite bearish for the fund, while the inverted head and shoulders pattern is considered a bullish signal.

A chart pattern that is easy to identify and has a high degree of reliability is the double or triple top or bottom. A double top or triple top is typically formed after a long period of time and indicates an impending trend reversal; if a mutual fund trending higher can’t break through this formation, it could be headed lower. Conversely, a fund that has formed a double or triple bottom may be poised to move higher.

The Bottom Line

While mutual funds do not lend themselves readily to technical analysis, investors can apply some common technical indicators to predict mutual fund movements. Technical indicators such as trend lines, moving averages, RSIs and chart formations are widely used in mutual fund analysis as they provide reliable signals that are easy to interpret.