Investors, traders and analysts have been using technical analysis to accomplish broad acceptance among the academic community and regulators – specifically pertaining to the behavioral finance aspects.
Although technical analysis trails predefined principles and rules, the results’ interpretation is generally subjective. This means that though some aspects, like the indicators’ calculation, follow specific rules, the explanation of discoveries is often based on a combination of techniques that suit the approach and style of the individual analyst.
In this post, let’s highlight technical analysis and learn more about it.
What is technical analysis?
Technical analysis is referred to as a trading discipline that is used to assess investment instruments such as stocks and discover trading opportunities by evaluating statistical trends accumulated from varying trading activities, like volume and price movement. It mainly concentrates on the study of volume and price.
Understanding Technical Analysis
Technical analysis was first brought into the picture by Charles Dow in the late 1800s. Later, many credible researchers, such as John Magee, Edson Gould, Robert Rhea, and William P. Hamilton, contributed to the Dow Theory to form its basis. Today, it comprises hundreds of signals and patterns curated through years of comprehensive, profound research.
Technical analysis is generally used to examine how demand and supply for security will impact volume, price, and implied volatility changes. It functions from the supposition that previous price changes and trading activity of the security can be valued indicators of the security’s future price movements when combined with adequate trading or investing rules.
Often, it is used to generate short-term trading signals from various charting tools. It can also assist in assessing a security’s weakness or strength related to the broader market or sector. With this information, analysts can easily enhance their valuation estimates.
Types of Technical Analysis Charts
There are three primarily popular technical analysis charts, such as:
- Line Charts
A line chart is extremely basic and simple. It comprises one single line that tracks the stock’s closing price movements. Traders use it to gain a basic understanding of the change in stock prices. While this chart type doesn’t display much and may not provide extensive data, it offers a general idea of the price trend.
- Candlestick Charts
Candlestick charts showcase a specific stock’s closing, opening, low and high price during a trading session. However, these charts use candlesticks to display the results rather than a single line.
- Bar Charts
Bar charts are a bit more complex than line charts and candlestick charts. In this chart type, you will find a series of vertical lines. Every line depicts the closing, opening, low and high prices in one specific trading session.
Indicators of Technical analysis
Some such indicators of technical analysis primarily focus on categorizing the current market trend, including resistance and support areas. On the other hand, such indicators concentrate on comprehending a trend’s strength and its likelihood of continuation.
Some of the prevalently used charting patterns and technical indicators include:
- Momentum indicators
- Moving averages
- Channels
- Trendlines
Generally, technical analysts examine the below-mentioned indicators:
- Price trends
- Support and resistance levels
- Chart patterns
- Moving averages
- Volume and momentum indicators
- Oscillators
Example of technical analysis
For instance, let’s consider the S&P 500. Along with some exceptions, the 50-day moving average of the index has proven to be a dependable support level in the last few years. When the value of the S&P 500 goes above the 50-day moving average and retains that behavior, it is highly likely that the upward trend will continue. Thus, experts will purchase when there is any monetary drop below the line.
Uses of Technical Analysis
Often, analysts use technical analysis along with other research types. Retail traders might make decisions solely based on price charts of specific security and other similar statistics. However, practicing equity analysts seldom restrict their research to technical or fundamental analysis alone.
Traders can apply technical analysis to any security with historical trading data. This comprises:
- Currencies
- Fixed-income securities
- Commodities
- Futures
- Stocks
And other securities.
Technical analysis is more prevalent in forex and commodities markets, where traders prioritize short-term price movements.
The technical analysis attempts to predict the price movement of any instrument that can be traded virtually and is subject to forces of demand and supply, including currency pairs, futures, bonds, and stocks. Some experts consider technical analysis a simple study of demand and supply forces mirrored in a security’s market price movements.
Most commonly, technical analysis is applied to price changes. However, some analysts keep track of numbers and not just prices, such as open interest figures or trading volume.
Technical Analysis vs Fundamental Analysis
As far as approaching the markets is concerned, both technical analysis and fundamental analysis work at the different ends of the spectrum. Both methods are used to research and predict future trends in stock prices. Moreover, like any philosophy or investment strategy, both have their adversaries and advocates.
Fundamental analysis is a method that assesses securities by attempting to evaluate a stock’s intrinsic value. Fundamental analysts generally study everything from the overall industry and economic conditions to the financial condition as well as the management of companies. Some of the important characteristics of a fundamental analyst are:
- Liabilities
- Assets
- Expenses
- Earnings
Talking about technical analysis, price and stock volume are the only inputs. The principal assumption is that every known fundamental is factored into the price. Hence, you don’t have to pay any close attention to them. Generally, technical analysts don’t put effort into evaluating a security’s intrinsic value. Instead, they use stock charts to discover trends and patterns that suggest what stock could do in the future.
Conclusion
Now that you have understood technical analysis, remember that there is no such technical indicator that is perfect. None will offer 100% accuracy all the time. So, being an intelligent trader, ensure you watch for warning signs. When done well, technical analysis can surely help you gain profits. However, you must spend more time and invest more effort into handling everything in a better way.
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