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 to shorter-term trading.

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

1. Trendlines

Most technical analysis starts with trendlines, which are lines that connect multiple 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 in order to determine its trend.

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

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

2. Moving Averages

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

A second major application arises from the crossover 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, this would be considered a bullish signal for the mutual fund. Conversely, if the 20-day moving average breaks below the 200-day moving average, this would be a bearish signal.

The 200-day moving average is considered a key technical indicator, with breaks above or below that regarded as important trading signals. It is especially suited for mutual fund technical analysis because of 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 in order to evaluate whether the mutual fund is overbought or oversold.

An RSI above 70 would suggest that the mutual fund is overbought and its value is overpriced and poised to retreat. An RSI below 30 indicates an oversold state that may trigger a bounce, which may bolster a value investor's buy decision.

4. Support and Resistance

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

The further apart these tests of support and resistance, and the more frequent that the fund trades down or up to the support or resistance level, the more formidable they become. A break of long-term support is very bearish and may signal a substantial downside for the mutual fund. A move above long-term resistance is very bullish and signals 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 point-and-figure charts. Chart formations for a mutual fund can be interpreted like stocks. The head-and-shoulders pattern, for instance, is interpreted as being quite bearish for the fund, while the reverse head-and-shoulders pattern is viewed as a bullish signal.

A chart pattern that is easy to identify and that 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 and signals an imminent trend reversal; if a mutual fund that has been trending higher is unable to break through this formation, it may 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 readily lend themselves to technical analysis, investors can apply some common technical indicators to predict mutual fund movements. Technical indicators like trendlines, moving averages, RSIs, and chart formations are widely used in mutual fund analysis as they provide reliable signals that are easy to interpret.