Technical analysis is a study of stock prices or any currency pair to predict the future price movement of the security. Through a proper study of technical analysis, one can make huge profits in the financial markets. Technical Analysis helps to buy a stock at a lower price and exit at a higher price.
Overview of Technical Analysis
Table of Contents
- 1 Overview of Technical Analysis
- 1.1 What do you mean by Technical Analysis?
- 1.2 How does Technical Analysis work?
- 1.3 Purpose of Technical Analysis
- 1.4 Why Technical Analysis?
- 1.5 Technical Analysis Example (NIFTY)
- 1.6 Technical Analysis of Stocks
- 1.7 Difference between Fundamental Analysis vs Technical Analysis
- 1.8 Advantages
- 1.9 Technical Analysis Chart
- 1.10 Conclusion
What do you mean by Technical Analysis?
Technical analysis in trading is used to test investments and identify the opportunities. This analysis is done with the help of the gathered historical data with the help of past price movements. A thorough study takes place for future financial price movements.
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Technical Analysis can be like the Weather report. How weather reports help us to predict what likely the temperature is going to be, the same way Technical analysis will help the investors to know the prices of the stocks.
How does Technical Analysis work?
Technical analysis focuses on how a security price moves in either direction with the help of different chart patterns or various types of candlestick formations. Also, technical analysis work based on a few assumptions. The assumptions are:
- Liquidity is at a high rate:
The technical analyst considers a simple rule that low liquidity stocks are priced low, where high liquidity stocks are priced more. The stocks which are quickly and easily traded don’t affect the price of the stocks. The stocks whose price does not change dramatically are called heavily traded stocks. Whereas stocks whose prices need to be altered depending upon the buyer and seller are called thinly traded stocks.
- No extreme events take place:
A technical analyst does not assume extreme events to take place while working on technical analysis. Events such as terrorist attacks, the sudden demise of the CEO of the company, etc. During such events, you need to wait patiently for the chart to settle down.
- Artificial Price Change:
Artificial prices will affect the price chart of the stock. The analyst does not consider artificial prices while carrying out technical analysis.
The technical analyst looks at the following indicator while studying. The indicators are
- Price Trends
- Chart patterns
- Volume Indicator
- Momentum Indicators
- Moving averages
- Support and Resistance level
Purpose of Technical Analysis
It is based on understanding the demand and supply forces in the security. That is if demand is more then it will lead the price higher and if supply is more then it will push prices at a lower level. The basic purpose of technical analysis is to enter and exit at a proper price.
Why Technical Analysis?
It is preferred more than fundamental analysis. The reason being in fundamental analysis you are focusing more on a company’s work profile and not on the price of the stock. It is purely focused on the price of the underlying asset irrespective of the company’s balance sheet or various ratios.
It is possible that an investor can get to know about the company’s loss in a specific quarterly or yearly result because of which he wants to exit the stock, but by the time he exits his position from the stock price has already fallen reasonably from its high thereby making his gains decline.
Whereas in Technical Analysis you get to know that prices are going to fall based on various chart patterns and candlesticks formation because of which a technical analyst will exit earlier from the stock as compared to a fundamental analyst hereby making more gains.
Technical Analysis Example (NIFTY)
Nifty was trading at all-time high levels where it made a bearish engulfing pattern along with not able to cross its high of 11762 for three to four consecutive days hereby making a resistance zone.
After the bearish engulfing pattern was formed at the top Nifty fell 1700 points.
Also on the weekly time frame, BEARISH HAMMER candlestick pattern was formed indicating selling pressure. In any case nifty was a perfect short candidate at least below its previous all-time high of 11172.
Technical Analysis of Stocks
Tata Motors, one of the most loved stocks of investors to keep in their portfolio made a DOUBLE TOP PATTERN on the weekly time frame on 6th Sep 2016 at the price of 598, meeting its previous top of 606 dated 2nd Feb 2015.
Along with the double top pattern, there was also a reversal pattern on lower indicator i.e., RSI. RSI was at 68.50 when the stock traded at 606 and later when the stock made a high of 598, RSI made a new high of 77.50 indicating a reversal in an indicator. Thus a clear sign to at least exit your stock if not shorting it.
Later on stock came into a downtrend making lower highs and lower lows suggesting that there are no long term investors and also not willing to buy stocks at lower levels.
Dated 31st July 2019 the recommendation for the stock is to sell once it closes below its all-time low of 129.CMP IS 135.50. One can try to take a contra trade as well.
Difference between Fundamental Analysis vs Technical Analysis
Fundamental Analysis and Technical Analysis are the two methods that are used for researching and forecasting the trends of the stock prices. If you are a strong believer in reading charts and trends then you are a technical analyst person.
Whereas if you are a person who believes in making an investment based on financial, growth and EPS then you are a fundamental analyst person. Some might even consider to study both the methods and then take trading decisions.
|#||Fundamental Analysis||Technical Analysis|
|Meaning||In fundamental analysis, one tries to calculate the intrinsic value of the stock.||In technical analysis, one tries to find the value of the company.|
|Time Period||Fundamental Analysis approaches in long term investment as it takes time to calculate the intrinsic value of the stock.||Whereas, It is considered as a short term investment strategy as it is based on the market trend.|
|Factors||The factors that are looked while studying fundamental analysis are revenue, income, and expenses, growth aspects of the company, competitive factors, expected return on equity.||The factors that are looked while studying technical analysis are the Historical price of the stock, volume of trade, trading trends.|
|Function||Fundamental analysis is you investing in the company relying on their value for your return.||It is a trading strategy where you aim your return based on trends and opportunities.|
|Gathering of Data||The fundamental analyst gathers information through financial statements.||The Technical analyst gathers information through charts.|
|Goal||The goal through fundamental analysis is to find the intrinsic value of the stock.||The goal of the technical analysis is to find the right time to enter and exit the market based on past and current trends.|
|Vision||In Fundamental analysis, we look backward as well as forward and make decisions.||In technical analysis, we look backward and make decisions.|
It can be used in any markets and in any time frame. Technical Analysis shows a graphical representation of human behavior about the underlying security. It can be applied to stocks, currency, CFDs, options and many more. This means you don’t need to understand each market individually because the prices are moving based on human emotions.
There is a great opportunity for those who are well versed with reading charts and making quick decisions about when to enter and exit. The advantage of technical analysis is it can be used in any security which has demand and supply forces. It can be used in any time frame. (short term, long term, and intraday trading)
- Focus on Price:
When your goal is to focus on predicting the future price, then you need to focus particularly on the price movements.
- Keep a close look at the supply, Demand and price action:
While analyzing the price of some security, many technicians have a close look at the open, high, low and close of the security. These will reflect the forces of demand and supply. Higher Price states increase in demand and lower price states increase in supply.
- Trend Analysis:
The main advantage or a purpose for understanding and trading based on technical analysis is that it gives you an idea about the current trend in the market, uptrend, downtrend or sideways market. It also helps you a proper entry and exit point hereby making huge profits. The direction of the stock is important in analyzing the trend.
- Provides all the current information:
It believes that the price provides all information on the asset. Rumors do often get swirl in the market but the price of the security discounts everything. With the focus on the price chart, trading is made much simpler. All the information that we need is recorded in the Price chart.
- History Repeats:
It believes that history repeats itself, meaning that the pattern formed on the chart will tend to repeat itself on some future date. This doesn’t mean that it will repeat exactly. The technicians use history as their guide and the current price as their catalyst.
- Entry/Exit Point:
Technical Analysis helps a trader or an investor to time the market. Through technical analysis, one can exit at a higher price and enter into a stock at a lower price. Timing is the most important factor in trading and investing. Fundamental analysis is used for the long term entry/exit points whereas Technical analysis is used for the short term entry/exit points. Here we will come to know when we can go into the game and buy some stock.
- Quick and less expensive:
It is preferred more in trading and investment due to its Quick studying nature and less expensive. When compared with fundamental analysis, Technical analysis is a money saver. And with the help of 1-min, 5-min, 30-min, and 1-hour charts, the analysts get faster and quick results.
- Volume Trend:
The market is usually governed by supply and demand. High demand will push the price higher and high supply will push the price downward. Through this analysis, you will come to know how the market will work. Technical Analysis helps to make trend-based trading systems meaning a trader or an investor will always be with the trend of the market and make the trend as his friend.
Technical Analysis Chart
Earlier the charts were drawn manually, but computers have made the task easy for the analysts. Studying of Chart in very much important in technical analysis. Every chart has its utilities. Usage of which chart depends upon the trader and his/her strategies. You must take care of the following points while studying the Technical Analysis of any of the Stock.
- Overall Trend
The various types of technical analysis are Line Chart Pattern, Bar Chart Pattern, Candlesticks Pattern, and Point and Figure pattern.
- Line Chart:
Line chart pattern means the movement of the price of the security is shown in the form of a line diagram. It connects the closing price values with a line segment. It is the most basic form of charts. This chart is generally used while representing a historical and current direction. A line chart does not provide more in-depth information other than the closing price.
- A Bar chart or Open-High-Low-Close chart:
The bar chart pattern represents the OPEN HIGH LOW AND CLOSE of the stock of in a bar form of the selected period. This chart is used to plot the span between high and low prices. Bar Charts help in discovering the patterns more easily.
- Point and figure chart:
The point and figure chart ignore the time entirely while its preparation. It applies numerical filters reference with time. This chart is not a well-known chart we can say.
Candlestick Pattern represents the daily movement of the stock in the form of a candle which is either green or red. The green candle represents the price has closed above its open price or a red candle represents the stock has closed below its opening price. It is the most used method of showing price movements in the chart. The colors used in the candlesticks charts are arbitrary choices.
The analyst visualizes candlesticks charts easier than using the standard bar chart. Black candle shows that there was hardly any difference in the opening and closing price of the security. The line which extends above and below of the candlestick is called upper shadow and lower shadow. Upper shadow represents high price whereas lower shadow represents low price.
- Renko Chart:
Unlike other charts, Renko charts precisely concentrate on the price movement. These Renko charts consist of white/green and black/red bricks. These bricks are placed based on price rise in comparison to previous brick. If the price is high compared to the previous brick white and green bricks and used and if the price goes down compared to the previous brick red and black brick is used.
- Heikin Ashi:
This chart was originated in Japan. This chart is very much like the candlestick chart. The Upward and downward trend is more clearly seen in Heikin Ashi. It is used more as an indicator rather than a chart.
The Technical analyst considers the market to be 80% psychological and 20% to be logical. Whereas fundamental analyst considers it to be the exact opposite. 20% psychological and 80% to be logical. Always remember a technical analyst is more like an art rather than considering it as a science. Also, you must never forget any technical analyst’s indicator is perfect. None of them are accurate 100% of the time.
Hence to improve your fortunes spend more time and effort in analyzing the market turns in your favor rather than thinking on how to spend those millions.
Hence, technical analysis will help you to determine the short term as well as the long term trends of the market. With the scope of technical analysis increasing day by day, more people are trying their hands-on learning the technical analysis and get good returns.