In today’s fast-growing financial market, everyone gets attention to the stock market. Before entering into this zone, we need to understand the concept of the stock market. In this article, we discuss technical analysis, how it works in the stock market, and its advantages and disadvantages.
What is Technical Analysis?
Technical analysis is one way to evaluate the price movement and make trading and investment decisions based on past data. Technical analysis is the study of past price movement to predict the future of price movement in which we study the share price and trading volume to predict the future.
In simple words, analyze the past and predict the future.
Understanding Technical Analysis
In technical analysis, we make assumptions using past share price movement and traded volume about the future price movement. It is used to generate trading signals from various charting tools.
Charles Dow and the Dow Theory first introduced technical analysis in the late 1800s.
Any security can be subjected to technical investigation. using historical trading data, including stock, futures, commodities, currency, and other securities.
The goal of technical analysis is to make predictions of future growth prices. Without proper study, if you invest or trade in a market without appropriate study, it is like catching a falling knife.
A Good Technical analyst always stays away from emotions like greed and panic while making their trading decision.
Dow Theory Principle
Here are three dow theory principles,
1. Price discounts everything – whatever price you are seeing now has all the information going on in the stock or index. Thus, they believe the study of price action is all that is required.
2. Trends are confirmed by volume.
3. Trends exist until definitive signals prove that they have ended, etc.
Basic Indicators for Technical Analysis
We must be aware of basic technical analysis indicators because these are very crucial in trade decisions. Here are the main basic indicators for technical analysis:
Trendline
A trendline is the most important tool used by technical analysts and is a simple line that represents the trend of the price movement.
Trendline is drawn to determine the overall direction of the price movement, and it’s nothing more than the general direction of price movement.
Chart Pattern
Charts are an integral part of the technical analysis. These patterns are identified on a chart using trendlines, which are used to make short-term and long-term forecasts of future prices.
Common Chart Patterns
Here are the most commonly seen chart patterns:
- Head and Shoulder
- Inverted head and shoulder
- Double Top
- Double Bottom
- Rounding Botton
- Cup and handle
- Rising wedge
- Falling wedge
- Symmetrical triangle pattern
- Ascending Triangle Pattern
- Descending Triangle Pattern
- Pole and Flag Pattern, etc.
Volume
Volume is a very important element of technical analysis and is defined as the total number of shares traded on one side of the transaction during a given period.
Low-volume stocks should be avoided for trading.
There is a rise in the volume with the formation of a chart pattern, which is a positive signal for the particular security.
Support and Resistance
Support is a price level below which the stock has failed to continue its downtrend.
Resistance is the price level above which the stock fails to close.
Support and resistance were like the floor and ceiling of a room.
At the support level, buyers get activated, and at the resistance level, sellers get activated.
Support and resistance are interchangeable.
There may be multiple support and resistance levels on the chart.
The more support and resistance are tested, the weaker it becomes.
Supply and Demand
The stock market operates based on demand and supply.
If the demand exists exceeds the supply, the price will rise. When supply surpasses demand, the price falls.
The Technical analyst finds the zone from where prices rise and fall and names them as the supply and demand zone.
Various Other Indicators
The study of technical analysis is done with the help of indicators.
Multiple indicators are used to determine the momentum, trend, volatility, etc., of the market. One can develop their Strategy using a combination of different indicators or can combine indicators along with price action for confirmation.
Some of the indicators are:
- Moving Averages
- MACD
- RSI
- Bollinger Bands, etc.
Technical Analysis for Trader vs Investor
Traders want to take advantage of the short movement of the price, whereas investors want to take advantage of the long-term price movement of the security.
Investors can use technical analysis to identify long-term price trends, and they cancel out the short-term volatilities. In contrast, traders use the same volatility in the faver using technical analysis.
Underlying Assumptions of Technical Analysis
Here are two main points to be considered while making a technical analysis.
Price Moves in Trends
Technical Analysts expect that the stock price is more likely to continue the past trend, and this premise underpins the majority of technical trading systems.
History Tends to Repeat Itself
This happens because the market participants consistently react to price movements in a remarkably similar way every time.
How can I Learn Technical Analysis?
There are various ways to learn technical analysis, which include books, online courses, online tutorials, certified technical analyst courses, and classes. For those who are beginners in the stock market and want to learn technical analysis from the basics, Trading Baate is one specific option in the market.
What is Technical Analysis of Stocks?
Technical analysis is how the stock has performed historically, which means how the pricing and trading volumes have changed over time.
The purpose of technical analysis is to study what happened previously with the stock and use that information to forecast the future movement of the price of that particular stock. This help to make trading or investment decision In that particular security.
How to Evaluate Stocks Using Technical Analysis
There are various free tools available to filter out the stock for trading and investing based on different parameters in which you want to conduct technical analysis. For example, you could screen stocks based on their price and market capitalization and scan for stocks making 52-week highs or all-time highs, 52-week lows or all-time lows.
Now, from a selected list of stocks, you could screen stocks based on which sector or industry they represent. For example, if you are interested in tech and IT stocks, you can filter out of them.
This stock selection process is known as the top-down process.
Now you have your shortlist of stocks, and the next step is to conduct a technical analysis. For example, you only want to focus on charts that are making chart patterns, then take a closer look at their technical chart and try to identify emerging and completed chart patterns.
Along with the chart pattern, you might look at different indicators for confirmation. For example, check whether the price is above the 200 moving average or below the 200 moving average to check the long-term trend of the particular stock.
Consider including various other technical parameters, such as support and resistance, trading volume, etc., before making any trading decision.
Strength Of Technical Analysis
Everything is Organized Graphically
In technical analysis, past, present, and potential future, the charts represent everything. Graphical representation simplifies complex market information.
Once we start to understand what the chart wants to tell us, we need nothing more. Charts provide us with a visual framework for making informed trading decisions.
Entry and Exit Points
Technical analysis provides us with exact entry and exit points. Technical analysts use support resistance, chart patterns, and candlestick patterns to identify the potential entry and exit points.
Investors can use technical analysis in their favor by identifying the trend of the stock on larger time frame charts and finding out whether it is the right time to invest in a particular stock or not.
Applied Anywhere
Technical analysis is a versatile technique that can be used in a variety of situations in the financial markets and asset classes. The stock market employs technical analysis, option and derivative market, forex market, currency market, commodity market, cryptocurrency market, etc.
Quick Snapshot of Data
Technical analysis represents the huge complex data in simple graphical form. Price, volume, open interest, and all the data are represented on one chart, which helps the technical analysts determine target stop loss.
Weakness Of Technical Analysis
Everything has merits and demerits, and here are the weaknesses of technical analysis:
Lagging Indicators Aren’t Always Appropriate
Indicators have their limitations and are based on specific formulas which may provide delayed information to the trader. In contrast to indicators, price action offers more timely and forward-looking insights.
Tools Are Available to Everyone
In today’s digital world, tools are available to everyone. From the newbie, open an account, and the information is easily available.
Assumption Not Accurate
Technical analyst makes future assumption by analysing the past movement on the chart, which is not always accurate, and this may become the reason for huge losses in the stock market if proper risk management and psychology are not followed.
Always Another Level
There is always another level on a chart, which increases the difficulty for a technical analyst to make a trading decision.
Last Words
In this article, we learned about technical analysis, from basics and their advantages and disadvantages.
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