Technical Analysis is a method of evaluating securities by analyzing data generated by past market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. They believe that the historical performance of stocks and markets are indications of future performance.

Technical Analysis is one of the main tools used by Active Traders, and hence, would be very useful for you, if you aspire to become an Active Trader. We recommend a detailed study of the subject to ensure proper understanding of concepts and ideas.

The field of technical analysis is based on three assumptions:

1. The market discounts everything - At any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors. Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately.

2. Price moves in trends - After a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it.

3. History tends to repeat itself - The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time.

Terminology

Charts - A chart is simply a graphical representation of a series of prices over a set time frame. For example, a chart may show a stock's price movement over a one-year period, where each point on the graph represents the closing price for each day the stock is traded.

Charts can be divided into various types depending on the way they are plotted. Hence, there are Line Charts, Bar Charts, Candlestick Charts and Points and Figure Charts.

Trends - One of the most important concepts in technical analysis is that of trend. A trend is the general direction in which a security or market is headed. There are 3 types of trends – Uptrend, Downtrend and Sideways/Horizontal trend. The meaning of all the 3 is apparent from their names.

Trend lines - A trend line is a charting technique that adds a line to a chart to represent the trend in the market or a stock. Drawing a trend line is as simple as drawing a straight line that follows a general trend. These lines are used to clearly show the trend and are also used in the identification of trend reversals.

Support & Resistance – Technical Analysts often talk about the ongoing battle between the bulls and the bears, or the struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom moves above (resistance) or below (support). Support is the price level through which a stock or market seldom falls, whereas, resistance, on the other hand, is the price level that a stock or market seldom surpasses.

Resistance level

Support level

Support and resistance analysis is an important part of trends because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important level of resistance that has been tested several times but never broken, he or she may decide to take profits as the security moves toward this point because it is unlikely that it will move past this level.

Support and Resistance levels in Uptrend and Downtrend

Channels - A channel, or channel lines, is the addition of two parallel trend lines that act as strong areas of support and resistance. The upper trend line connects a series of highs, while the lower trend line connects a series of lows. A channel can slope upward, downward or sideways.

Chart Patterns - A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements. Chartists use these patterns to identify current trends and trend reversals and to trigger buy and sell signals. There are various kinds of patterns, like Head & Shoulders, Cup & Handle, Double Tops & Bottoms, Triangles, Flags & Pennants, etc.

Moving Averages - A moving average is the average price of a security over a set amount of time. By plotting a security's average price, the price movement is smoothed out. Once the day-to-day fluctuations are removed, traders are better able to identify the true trend and increase the probability that it will work in their favor. The three most common types of moving averages are simple, linear and exponential.

Indicators - Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. Indicators are used as a secondary measure to the actual price movements and add additional information to the analysis of securities. Indicators are used in two main ways: to confirm price movement and the quality of chart patterns, and to form buy and sell signals.

There are two main types of indicators: leading and lagging. A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods.

Technical Analysis is a very vast and complicated subject. We recommend our visitors to do a detailed study of the same, before using it as a tool for analyzing the markets. The above explanations are only a basic representation on this extensive subject. You can also practice Technical Analysis on this website, by clicking here.

Top