Meaning & Definition

Technical analysis is a strategy used to aid the decision-making procedure is simplified by day traders. Technical analysis is built on real fundamental principles while you'll find an infinite number of sophisticated strategies. The basic techniques in technical analysis are not very simple, but no doubt they can supply another important view point which can enter to your broad investment strategy and help you to get the right decisions.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities.

Technical analysis as we know it today was first introduced by Charles Dow and the Dow Theory in the late 1800s. Several noteworthy researchers including William P. Hamilton, Robert Rhea, Edson Gould, and John Magee further contributed to Dow Theory concepts helping to form its basis. Nowadays technical analysis has evolved to include hundreds of patterns and signals developed through years of research.

Technical analysis as a methodology for forecasting the direction of prices. This is done through the study of past market data, primarily technicals like price and volume. Price is the rate at which the security traded at different points in time. Volume is the amount of trades that were done. There are breadth indicators, price based indicators, volume based indicators and mixing indicators.

How Technical Analysis work

By using historical price data, technical analysis attempts to interpret the supply and demand that moves share prices. Dinosaurs can’t walk in the sand without leaving footprints. The dinosaurs are the institutions, mutual and hedge funds. They are the participants that move stock prices. Technical analysis visually tracks the activity of the dinosaurs using various charts and indicators to pinpoint price areas of strong interest both in terms of buying and selling. History tends to repeat itself as evidenced by price patterns.

Who can use Technical Analysis

Anyone who trades or invests in the stock market or any other tradable financial instrument should consider learning at least a basic level of technical analysis. If your money is invested into a position that has price movement, then technical analysis will help you make better-informed decisions as to how much risk to employ for how much potential reward.

Basics of Technical Analysis

Technical analysis involves and utilizes various tools and indicators. The right mix of the tools can be used to generate converging signals that improve the probability of a direction price move.

Stock Charts

Technical analysis seeks to interpret the story of a stock’s price action. Charts act as the canvas where the story is painted. The common types of charts are candlestick, bar and line charts. Charts plot the prices where trades have been executed. The time interval of the chart can be specified through the settings. Time intervals segment the price action of the stock.

For a 5-minute candlestick chart, each candle represents a five-minute segment of trading that record the starting price (open), the highest price (high), lowest price (low) and last price (close) trade during the period. As the five minute window ends, it will display a candlestick that details the four data points (open, high, low, close) and a fifth data point that encapsulates the opening and closing price (body) and colors the body red if the last trade (close) is lower than the first trade (open), or green if the last trade (close) has a higher price than the first trade (open). Bar charts include the same information without painting the body. Line charts simply connect the closing price only for each time period.

Support/Resistance

By visually marking the charts, users can see certain price levels that tend to prevent prices from falling any further before rising back up again. These are known as price support levels. Users will also spot price levels that continue to provide a ceiling, those eventually causing prices to fall back down again after testing. These are known as price resistance levels.

Stock Volume

Volume measures the total number of shares traded for a specified period of time. It is used as a measure of interest that can manifest into significant price action. High volume indicates significant trading activity that triggers a breakout or a breakdown accompanied by a sustaining trend in prices. Breakouts result in higher trending prices and breakdowns result in lower trending prices. When volume is light, stocks tend to chop around in a range known as consolidation.

Trends

Trends indicate the current direction of share prices. When stock prices continue to rise higher, it is considered to be in an uptrend and vice versa for a downtrend. Uptrends indicate increasing demand for shares, as buyers are willing to pay higher prices as supply diminishes. Downtrends represent an oversupply of shares with waning buying interest resulting in falling prices. By connecting the various high and low points on a chart, you can manually generate trendlines that pinpoint support/resistance and direction of stock prices. When compared to historical templates of similar trendlines, you may be able to forecast the future direction, turning/inflection points and targets.

Every investor wants to find high profitability trading setups, but the thing is they don’t know-how. Instead of looking at the prices, you are looking at indicators without understanding their purpose. Instead of following trends, you are predicting market reversals. Instead of proper risk management, you are putting huge bet as the trade feels good.

If we learn about technical analysis and implement it in a simple way, we can consistently make profits from technical analysis.