Technical analysis is one of the most used trading tools on Wall Street, but it is also one of the most controversial trading tools. Fundamental analysis traders consider technical analysis to be ineffective and illogical, while technical analysis traders insist on its effectiveness and importance in trading in the financial markets.
In this article, we will learn what the importance of technical analysis is and what are its characteristics
What is Technical Analysis?
The community of traders is divided into two camps; the fundamental analysis camp traders buy and sell the shares of a company depending on the financial measures of this company, where they monitor the profits and revenues of the company and look at the number of subscribers and their growth and what are the debts owed by the company.
Technical analysis camp traders are not interested in anything about the underlying company. Instead, traders who use technical analysis look at a stock chart only to analyze past price action and predict what might happen next. Technical analysis traders rely on price patterns, trends, and signals to determine when stocks are bought and sold.
Why technical analysis?
The idea that a specific pattern in a stock chart affects whether traders buy or sell that stock may seem counterintuitive. However, investors who reject technical analysis may view it the wrong way.
The charts do not necessarily dictate traders’ decision-making: they are instead a visual representation of market psychology.
Take the famous downward head and shoulders pattern. The pattern usually forms at a high that the market achieves after a long rally. At first glance, it may seem like an arbitrary pattern in the form of a bust. When looking closely, the head and shoulders configuration is a visual representation of the shift in market thinking during the transition from an uptrend to a downtrend.
The concept of Technical Analysis
There are many ways to analyze whether an investment is good or not, or when you should buy or sell it. Financial markets in general, economic data, financial data, and fundamentals can be useful factors that must be examined when considering a new investment – whether it is a stock or another type of financial product.
One of the main ways for analysts and investors to identify suitable investments is to use technical analysis.
Unlike fundamental analog analysis, the technical analysis examines trends and price action to analyze a potential investment’s viability.
Technical analysis is a process used to examine and predict future prices of a security or financial instrument by looking at price movement, charts, trends, trading volume, and other factors. Unlike fundamental analysis, technical analysis focuses on trading signals to identify suitable investments and trading opportunities by examining investment trends through trading data and other statistical elements.
As a general rule, the technical analysis estimates the current or last price of a financial instrument as the best indicator of the future price. Technical analysis relies heavily on charts, financial data, and statistics to reveal investment strengths or potential weaknesses and expected trends to help analysts and investors determine whether a financial instrument is investable and for what action.
Technical analysis versus fundamental analysis
Unlike technical analysis, fundamental analysis focuses on a financial instrument’s intrinsic value based on things like the company’s financial statements, the general economy, market conditions, and other factors such as liabilities and assets. While technical analysis focuses on the price movements and volume of securities, the fundamental analysis looks at its viability at the fundamental level.
Fundamental analysis is often qualitative and quantitative. It examines larger numbers and factors that may affect an investment’s value, such as interest rates, competition, and the general economy. In contrast to technical analysis, which mainly focuses on price trends of securities, the fundamental analysis seeks to determine the fair market value of those securities and where they should be traded.
However, proponents of technical analysis argue that many of these factors affect or shape the price of a security.
Assumptions of Technical Analysis
Technical analysis relies on several basic assumptions that it uses to examine stocks and shares:
Technical Analysis | History repeats itself
A fundamental tenet of technical analysis is the assumption that History repeats itself, especially about security pricing. Technical analysts contend that prices move periodically over time, especially when looking at market behavior and human emotions. Looking at things like alternating emerging markets and bear markets, the “history repeats” hypothesis makes sense in a broader understanding of market psychology.
Because of this assumption, technical analysis frequently looks at chart patterns to track how the market functions over time and how prices are changing, using it as a potential predictor of future price movements.
Technical Analysis | The price and the market decide everything
The other primary assumption on which technical analysts base their work is that as the price is supposed to consider financial data, the economy, and the market in general, examining these factors separately is unnecessary.
In other words, technical analysts consider fundamental analysis unnecessary because many of the things fundamental analysts examine about securities or companies have already been included in the price of these securities, which makes the technical analysis even more important.
Technical Analysis | Prices are trend-driven
Finally, one of the most significant assumptions that technical analysis makes is that prices follow trends and do not move randomly.
A lot of technical analysis involves examining data and chart patterns of historical prices and current prices, as technical analysts believe these prices move in different directions such as the short, medium, and long term.
Fundamentals of Technical Analysis
Given that technical analysis focuses on price, movement, volume, and trends, technical analysts look at many fundamental aspects and charts rather than things like financial data, which fundamental analysts look at.
What are some of the basics of technical analysis, and how are they used in analyzing stocks?
Technical Analysis | Prices
One of the most significant factors that technical analysts examine is the price of a security. Indeed, price action is the primary measure that is taken into consideration when performing technical analysis.
Technical analysts begin by examining charts that show a stock’s price and trading volume to note its historical performance and help predict future movements. The primary function of using charts to examine stocks or other securities is to identify trends in investment price or trade volume and how they change over time.
Technical analysis looks at the investor’s attitudes and behavior (that is, the market’s psychological aspects) as the biggest driver of stock prices over time. Given the cyclical nature, trading patterns are often the case. They are also key indicators of how prices will move and change in the future.
Technical Analysis | Chart Patterns
Chart patterns are one of the main ways that analysts check and predict as stocks or stocks will trade along with this pattern.
One of the essential parts of technical analysis charts is the so-called “trend line,” which shows a financial instrument’s general price direction. Additionally, things like “peak/bottom analysis” and “moving averages” can help investors or analysts get better expectations of what stocks will do.
While the charts look very practical, they rely on plotting and giving a visual representation of investor emotion and market psychology, depicting price movements over time.
There are many types of charts that technical analysts examine, including candlestick charts, line charts, bar charts, and more.
Technical Analysis | volume
The other main factor used in technical analysis is volume. Volume is simply the number of shares or contracts traded for particular security over a certain period, which is usually one day.
Technical analysis, looking at the volume of stocks or securities, can help analysts determine the strength of a price movement or trend by showing the number of stocks trading in that direction (up or down).
In addition to helping confirm or demonstrate the strength of trends and price movements, the volume can help specific chart patterns such as the so-called “triangle” or “head and shoulders” (two types of technical patterns that measure the trading or price of a stock) (trends).
Technical Analysis | Trend
For a technical analyst, the trend is perhaps one of the most critical indicators of a stock or financial instrument’s future performance. The Technical Analysis Awards examine historical trends to predict what the stock price may do in the future. For this reason, human behavior and emotions play a surprisingly key role in technical analysis, as trading patterns and price movements from the past often indicate how a stock or financial instrument might behave in the future.
There are many different directions, some with strange names like “triangles” and “head and shoulders.” (Some other patterns include “rectangles,” “cup and handle,” “flags and emblems,” “candles,” and more.)
The three main types of trends are “bullish trends,” “downtrends,” and “horizontal trends.” Uptrends are characterized by high lows, while lower lows indicate downtrends. (Horizontal trends include highs and lows that are essentially unchanged.)
While you can enter by examining each different trend, trends represent the general direction of the stock price, which may include its highs and lows.
Also, trends have different lengths that analysts use to interpret the data – the most common are “short term,” “medium-term,” and “long term.” Stocks can see different trends in the short term (such as a short drop in price) while still experiencing long-term growth, so it is essential to understand the timeframe when analyzing trends.
Technical Analysis | Momentum
Momentum measures the speed of price changes or movements of stocks or stocks. Often along with the “Relative Strength Index” (RSI), momentum tracks and measures the rate at which prices increase or decrease over a specific period. For example, you can check the Momentum of stock price changes like Disney (DIS) – Get Report for ten days to see the rise and fall rate.
The RSI indicator sets stocks at a value between 0 and 100 and tracks whether the market is overbought or oversold. It is generally checked daily.
Technical Analysis | Support, and Resistance
When looking at charts and price movements of stocks or stocks, technical analysts will also examine a stock’s “support” and “resistance” levels. Those are the stock’s previous lows (support) and rallies (resistance) above or below the stock’s current price. This can help clarify whether the stock is in an uptrend or downtrend.
Support represents a price at which the stock demand is high enough to prevent the price from falling below this line. Conversely, resistance means the point at which stock sellers come to unload their shares, preventing the stock from moving above a higher price.
If the stock price drops below the last support line, this is terrible news that could indicate a downtrend for the stock. But if the stock breaks above the previous resistance line, this usually means that the stock is facing an upward trend. Support is the lowest price for a stock that supports it to stay higher, while resistance is the ceiling that prevents the share price from rising:
Once the stock breaks through the resistance line, it becomes this line—the new support line for the stock. Examining where the stock price is currently located between the support and resistance lines is an essential tool used by technical analysts to determine price trends. Since stock prices tend to bounce between support and resistance lines, both are crucial to predicting when the price will or will not move (and in which direction).
Support and resistance levels are significant in determining trends and when they may reverse. That is why it is one of the critical concepts of technical analysis.
Technical Analysis | Moving Averages
When looking at a daily stock chart, the zigzag lines up and down can sometimes look messy or confusing. This is why examining so-called “moving averages” – the average of past price movements for a stock – can help show trends more clearly. These focus on average price movements of security rather than daily changes.
There are two types of moving averages – ‘simple moving averages’ (SMAs) and ‘exponential moving averages’ (EMAs). The simple moving average takes the sum of all closing prices for a given period and divides them by the number of prices used. For example, you can calculate a 30-day simple moving average by adding the stock’s closing price over the past 30 days of the market and dividing by 30.
EMAs use a more complex formula that weighs the newer prices a little more than the old ones.
Technical Analysis | Indicators, and Oscillators
Apart from only support and resistance levels, technical analysts also examine some significant indicators such as “money flow,” “volatility,” “momentum,” and more to get a mathematical view of the stock.
Indicators are calculations based on statistics such as price and volume that help confirm chart patterns and other trends. They are designed to create buy or sell “signals” that help traders or analysts determine the best place to enter or exit a trade (and thus make the most money). By examining these indicators, analysts can better ascertain the movements in stock prices, and thus the viability of specific chart patterns that experts believe they see.
There are a lot of indicators that technical analysts use. Some of the key factors include “average convergence / divergence” (or “MACD”), “Aroon” or “Fibonacci levels”.
Indices can be “lagging” or “leading,” which means that they either use past data to help describe what is happening to the stock price or that they anticipate price movements in the future.
Some of these indicators are also “oscillators,” or tools that work by showing overbought or oversold conditions for stocks in the short term. Usually, oscillators are associated with a specific range (or between particular levels or lines).