Technical analysis is the study of past stock prices using stock charts. Stock traders study charts to help them predict the future of those prices.
Technical analysis entails methods used to analyze stock and make investments that fall into two fundamental categories: Technical analysis and Fundamental analysis.
Technical analysis, as explained, takes a rather different approach as opposed to fundamental analysis.
It does not care about the value of a company.
On the other hand, fundamental analysis focuses on analyzing the characteristics of company in order to determine or estimate its value.
In short, technical stock analysts are interested in just the price movements in the stock market.
Our focus in this report is technical analysis and it’s therefore important to dig a little deeper for a bigger picture.
In spite of the exotic and fancy tools it demands, technical analysis tends to focus more on the demand and supply ends of the stock market and an attempt to determine the trend or direction that the prices will take in the future.
Quite simply, technical analysts attempt to understand the emotions in the stock market by studying the market itself rather than the opponents.
Understanding the benefits and limitations of technical analysis helps identify a new set of skills and tools that will make you a more successful stock trader.
This report introduces advanced stock traders to technical analysis, providing you with the foundation required to understand more advanced concepts of technical stock analysis
Technical analysis is quite simply visual.
Therefore, it does not require you to have a degree in economics or finance, nor does it demand exceptional skills in math.
Basic Tenets of Technical Analysis
The basic idea of Technical analysis involves evaluating market securities on the basis of the statistics the stock market generates e.g. past prices and volume.
Nevertheless, it’s important to remember that Technical analysts are not interested in measuring a stock’s intrinsic value, but instead use tools such as charts to determine the patterns that will influence future activity.
Due to innumerable number of technical analysts who believe in the use of different strategies, the methods of technical indicators employed are also varied.
Some employ technical indicators, others technical indicators and oscillators.
In simple terms, technical analysts’ use of volume data and historical prices is what set them apart from their fundamental counterparts.
History Tends To Repeat Itself
One other essential aspect of technical analysis is that history repeats itself, particularly in price movements.
This repetitive nature of price movements is usually attributed to market psychology: market players tend to offer a consistent reaction to similar stock market stimuli over time.
Technical analysis employs chart patterns to help understand trends and analyze market movements.
Though most of these charts have been used time and again, they have stood the test of time to still be in use today and are among the best indicators of patterns and price movements that have a tendency to reoccur.
Price Moves in Trends
As far as technical analysis is concerned, price movements are believed to follow a trend which means that once a trend has been established, the future price movement of that stock is more likely to follow the same trend than to go against it.
Most technical trading techniques are based on this assumption.
The Market Discounts Everything
The major criticism of technical analysis is that it only focuses on the price movements, ignoring other important fundamental aspects of a company.
Despite this, technical analysis assumes that at any given point in time, a stock’s price indicates everything that has an impact on the business including the fundamental factors.
Technical stock analysts believe that technical analysis along with market psychology and economic factors; are all factored into stock which removes the need to consider these factors independently.
This leaves behind the analysis of price movements only, which in technical theory is a product of demand and supply for a particular stock in the market.
Trends in Technical Analysis
Trends are one of the most important concepts associated with Technical analysis.
Let’s begin by looking at the definition of what a trend is.
A trend is basically the general direction in which a stock is headed.
Prices do not tend to follow straight lines in any one direction but appear in chains of lows and highs.
In technical analysis, the movement of these lows and highs is what defines a trend.
For instance, upward trends are categorized as a series of higher highs as well as higher lows while a downward trend (downtrend) is about lower lows and lower highs.
Types of Trends
As their names suggest, when each successive trough and peak is higher, it’s known as an uptrend.
In case the troughs and peaks are getting lower, that’s a downtrend.
A little improvement down or up is the troughs and peaks is known as a horizontal or sideways trend.
If you want to get more technical, the horizontal sideways trend is not a really trend but a lack of a definite trend in either directions.
Trend lines are a simple charting technique that includes a line to a chart in order to represent a stock or the trend in the market.
Sketching a trend line is easy and is similar to drawing a line that takes a general trend.
The purpose of these lines is to show the trend as well as identify any trend reversals.
Importance of Trends
Trends provide a clearer picture of where the market is headed.
Though for a beginner in trading, it might be tricky to figure out chart analysis, trendlines and the fundamentals associated with them (as mentioned in this report) makes it an easier learning process.
It’s very important to understand as well as identify trends in order to trade with rather than against them.
The two most common and important sayings are “don’t back the trend” and “the trend is your friend.”
This can be confusing to beginner advanced traders but all in all, this helps illustrate how important trend analysis is for any technical trader.
Technical analysis has become very popular in the recent years.
However, it continues to throw people off due to lack of a proper understanding of how it works.
Still, it’s important to understand that technical analysis and fundamental analysis are not mutually exclusive strategies.
In fact, these two stock trading strategies are quite complementary.
Also, do not expect a single stock trading strategy to outperform in all market conditions.
However, if you are a fundamental stock analyst, you want to go deeper into technical analysis and use the technical tools to help you beat the stock market.
And yes, setting up and following trading rules using technical analysis is the only way you’ll limit your risks when the floor falls out of the stock market.