What is Technical Analysis?
Technical analysis, introduced by Charles Dow in the late 1800s, is a methodology for determining the future direction of a stock price by studying past market data. Technical analysis uses patterns and statistical trends in market data to identify trends and make predictions. Contrast this with fundamental analysis, which analyzes business performance, sales and earnings, dividends, economic forecasts, etc. to arrive at a securities fair market value. Fundamental analysis is usually associated with buy and hold strategies as opposed to shorter-term trading. Although technical analysis can be advantageously applied to long-term investment strategies, fundamental analysis is also necessary to sound portfolio management for long-term investing. These two approaches are foundational in that all other trading methodologies are based on them, they can be used in combination as well for predicting future stock prices.
Theory of Technical Analysis
The theory of technical analysis is based on three general premises. First, the market discounts everything. This means that sales, earning potential, market share, and other economic factors, including market psychology have already been priced into the security. Therefore, technical analysis does not consider the value of a security when predicting future price movements. Instead, it uses stock charts to identify patterns and trends that suggest what a stock will do in the future.
The second premise is that price change moves in trends. Even random price movements appear to move in recognizable patterns that repeat over time. The intention of technical analysis is to identify and follow existing trends, to determine when a trend is in place, when it isnt, and when a trend is reversing.
The third premise is that history tends to repeat itself. Price movement is repetitive, and this repetitive nature is attributed to market psychology. The idea is that market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysts use chart patterns to track how the market behaves over time and how prices change, and use this as a predictor for future price movements.
Technical Analysis should be the primary constituent of your trading plan. If you are an active investor or speculator, a comprehensive understanding of technical analysis is necessary. Fundamental analysis is advantageous in buy and hold strategies, but if you seek to profit from short, intermediate, and even long-term price fluctuations, technical analysis is optimal. If you wish to apply a hands on, practical approach to trading, technical analysis is optimal. Trying to predict short and intermediate-term price movements contingent on fundamental analysis is ineffective, you need to know technical analysis. If you are waking up every morning to analyze the market at open, and attempting to realize quick and substantial profits from market fluctuations, you need to learn technical analysis. Most investing and trading websites offer information and articles such as “Top 12 Tech stocks this year!”, or “Buy These 5 EV Stocks NOW!”. The information provided in these articles will not work, you will not trade with consistent profitability using this approach. Rarely, one of the stocks discussed in these articles will be a good winner, but at the expense of frequent and unnecessary losses. The only way to consistently profit is through educating yourself, applying the correct resources, and developing a successful trading strategy. Chasing “hot” stocks, hype stocks, and popular opinion stocks will not work. You may get a big win, infrequently, by chasing hype stocks and popular opinion stocks, but at the expense of several and significant losses. Your trading strategy can implement technical analysis, fundamental analysis, or both. However, the primary use of fundamental analysis involves determining the fair value of a stock to contemplate long-term investment decisions. “Long-term” in this context involves a time span of 5+ years. If you want realize quick and substantial profits, technical analysis is far superior. Think fundamental analysis is easier to perform than technical analysis? It isn’t. Fundamental analysis may be easier to learn for some people, but is one of the most time consuming approaches available. Through fundamental analysis, you must examine revenues, earnings, return on equity, profit margins, management structure, competitors, industry position, growth rate, growth potential, and other data to determine the fair market value of a stock. With technical analysis, you must develop a profitable trading strategy. Technical analysis does NOT have to be difficult! Check out our website and products to learn simple approaches to technical analysis and trading that actually work.
Your content goes here. Edit or remove this text inline or in the module Content settings.
Technical indicators are pattern-based signals produced primarily by the price and volume of a security. As noted, by analyzing historical data, technical analysis uses these indicators to predict future price movements. Technical indicators come in two forms: leading and lagging indicators.
Leading indicators are concerned with future events. You can use these indicators to anticipate price movements ahead of time. This lets you open or close positions at the start of the movement and ride a particular trend. Lagging indicators are concerned with confirming a current pattern. While leading indicators look forward at anticipated outcomes, lagging indicators look back at whether the intended result was attained.
Momentum indicators (leading): Identify the speed and volume of price movement by comparing prices over time. Examples include; Relative Strength Index (RSI), Stochastics Oscillator, Support and Resistance Levels, W%R Oscillator, and Fibonacci Retracement Percentages.
Trend indicators (lagging): Measure the strength and direction of a trend. The trend is considered bullish when prices move above average and bearish when prices move below average. Examples include Simple Moving Averages and Moving Average Convergence Divergence (MACD).
Volatility indicators (lagging): Measure the rate of price movements based on the highest and lowest historical prices. Examples include Bollinger Bands and Standard Deviation.
Volume indicators (leading and lagging): Measure a trend’s strength and direction based on averaging raw volume over specified time periods. An increase in volume usually precedes an emerging trend, and a drop in volume usually precedes an ending trend. Examples of volume indicators include On Balance Volume (OBV) and the Klinger Oscillator.