Technical Analysis is the study of historical price movements to identify known repetitive patterns and determine future price movements' probabilities through the use of technical concepts, technical indicators, and other analysis tools.
Technical Analysis, in general, is a vast subject as any technical concept used in share market trading and investing falls under it.
Below are some of the crucial aspects of Technical Analysis.
Price chart Patterns
Support and Resistance
Types of Trading
Let us explore all these aspects one by one.
Table of Content
How does Technical Analysis work?
Technical Analysts don't consider any aspects of fundamental factors for their trading. They believe only past information of 'Price' and 'Volume' of a stock is enough to predict the future movements.
Technical Analysis works on a few vital assumptions:
Price consists of all the Information – Any open or hidden information about stock will reflect in the price of the particular stock.
For example, a key person in a company came to know that his company will be benefitted immensely due to a new contract.
Hence, he decides to accumulate some shares with the help of others (insider trading or buying) for quick gains.
His accumulation results in extra volume compared to daily average volume and push the price on the upside.
Hence, a technical analyst can quickly notice these changes in the price and volume.
Price displays different Trends - A price can move in different trends along with time.
There are three types of trend:
A stock price can be on an uptrend for a few months. Later it can change the direction and can move in sideways or downtrend.
Understanding these trends and identification of the change in trend early can offer significant benefits to traders.
History trends to repeat – Only two factors drive the stock market – 1) Greed and 2) Fear.
Irrespective of change in the world's economy and advancement in technology, people make their trading decisions based on emotions. Hence, the same patterns appear again and again.
Technical Analysis vs. Fundamental Analysis
Fundamental analysis focuses more on qualitative aspects such as PE ratio, balance sheet, cash flow, debt-to-equity ratio, etc. They use all this fundamental information to arrive at the Intrinsic Value of a company.
If the stock price is undervalued, then fundamentalists plan to accumulate the shares assuming the price will reach its value in some time.
Technical Analysis focuses on price and volume. Technical traders use only this information to manage their trades.
Is Technical Analysis useful?
When you drive in unknown terrain, it is better to use Google Maps. Because most of the time, it will guide you in the right direction.
Similarly, if you are new to the share market, it makes sense to use technical analysis to guide you in the right direction.
Many people downgrade the importance of technical analysis. But what they forget is traders don't lose money because of technical analysis, but they lose money because they fail to apply proper aspects of technical analysis with discipline.