How to Apply Technical Indicators to Mutual Funds

Most investors evaluate mutual funds using the principles of fundamental rather than technical analysis. Mutual funds are generally long-term buy-and-hold investments, while technical analysis is better suited to short-term trading.

However, investors should not overlook the value of some common technical indicators that provide trading information 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.

Key Findings

Mutual funds are most often evaluated using fundamental analysis rather than technical analysis, which is more often used for short-term trading.
However, technical analysis can provide significant information about most investments and financial assets, including mutual funds.
Common technical indicators that can help evaluate a mutual fund as a good or bad investment include trend lines, moving averages, relative strength index (RSI), support and resistance levels, and charts.

1. Trend lines

Most technical analysis begins with trend lines, which connect multiple price points and extend into the future to determine 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 constructed by drawing a line connecting several mutual fund lows over time. The fund may have tested this trend line many times over the years. If the fund’s price finally breaks the established long-term trend line, it is a bearish signal. An investor in such a fund should consider selling its holdings in the fund if this occurs..

Conversely, a break above a well-defined trend line can be a bullish signal indicating that the investor should remain in the fund.

2. Moving averages

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

The second important application occurs as a result of the crossover of two moving averages, such as the short-term 20-day moving average and the long-term 200-day moving average.

If the 20-day moving average rises above the 200-day moving average, it will be considered 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 a key technical indicator and breaks above or below it are considered important trading signals. It is especially suitable for technical analysis of mutual funds due to its long-term nature.

3. Relative Strength Index (RSI)

Relative Strength Index (RSI) is a momentum indicator that compares the magnitude of recent gains with recent losses to gauge whether a mutual fund is overbought or oversold.

An RSI above 70 indicates that the mutual fund is overbought, overvalued, and ready to retreat. An RSI below 30 indicates an oversold condition that could trigger a rebound, which could support a value investor’s buying decision.

4. Support and resistance

A support level occurs when a mutual fund trades down to a certain level and then bounces back up. Over time, this level becomes an area of strong mutual fund support. Conversely, a resistance area forms when the fund fails to break above a certain price level.

Support and resistance levels highlight the direction of the market and help determine entry and exit points.

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

5. Formation of charts

There are several different types of charts used in technical analysis, the most common being line charts and histograms.

Experienced users may prefer candlestick charts to cross charts. Mutual fund charts can be interpreted as stocks. For example, a head and shoulders pattern is interpreted as quite bearish for the fund, while an inverse head and shoulders pattern is viewed as 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 or triple top usually forms after a long period and signals an imminent trend reversal; if a mutual fund that is trending higher fails to break through this formation, it may go lower. Conversely, a fund that has formed a double or triple bottom may be poised for growth.

Bottom line

Although mutual funds are difficult to analyze technically, investors can use some common technical indicators to predict the movement of a mutual fund. Technical indicators such as trend lines, moving averages, RSI and charts are widely used in mutual fund analysis as they provide reliable signals that are easy to interpret.