What Is Technical Analysis?

Technical analysis can be used to evaluate potential investments and determine when or if to sell. This is based on the belief that supply and demand influence the price of a security, and that future movements can be predicted by changes in them. Technical analysis, which analyzes past price movements to predict future price movements for a security or a group of securities, is more detailed.

An understanding of the basic principles and tools that are used in technical analysis can improve your investment research. Find possibilities of profit and loss using the probability calculator.

Technical Analysis

Charles Dow, the co-founder of The Wall Street Journal and Dow Jones Industrial Average, is heavily credited with the creation of technical analysis. Technical analysis does not analyze a company’s structure or balance sheet. Instead, it uses volume and price data to try to predict future security prices. Find the probability calculator.

Simply, price refers to the cost of one share of security. Volume is the number of shares of security traded within a certain time period, such as a day.

Technical analysis uses a variety of price charts to analyze volume and price. From these price charts, technical indicators can be derived that can indicate patterns in stock movement and signal whether to sell or buy.

The Key Takeaways

• Technical analysis is the study of past price movements in order to identify trends.
• Volume and price are the main data points that can be used to conduct technical analyses of stocks.
• There are many types of technical indicators. They are often combined with other types of information.
• Technical analysis differs from fundamental analysis in that it considers fundamental company information, while technical analysis only uses market data.

How technical analysis works?

Three main principles of technical analysis are:

• Everything is influenced by market action.
• Trends influence prices.
• History repeats itself.

• Market Action is the Key to Everything

Technical analysis’s first principle is the belief that the efficient market hypothesis is true. This means that the stock’s stock price reflects all information available about its value. Any new information that could affect the stock’s value is quickly and fully absorbed by market participants and reflected in the stock’s price.

• Trends Influence Prices

The second tenet is based on the belief that prices will continue moving in the same direction up until a technical indicator indicates a reversal. Investors can choose from many technical indicators.

This is where the idea of following a trend is important. An investor might decide to sell a security if it has been rising but the technical indicator indicates that it will fall.

• History repeats itself

Technical analysis’s final principle is that historical patterns in stock market movements tend to repeat. Market psychology is used to interpret price charts. This aspect of technical analysis uses market psychology. Market psychology refers to the collective sentiment of investors. This is what is believed to be driving the volatility in security prices. Investors who are positive about security will buy it, pushing the price up. If investors lose their optimism, they will sell the stock and the price will drop.

• Techniques for Technical Analysis

Technical analysis, as mentioned previously, involves studying past market activity in order to identify a trend change in a security’s price.

Technical indicators come in many forms, so most chartists and technicians will use more than one indicator when making investment decisions.

Here are some examples of technical indicators:

Bollinger Bands

Bollinger Bands show the difference between the current moving average price for the security and the standard deviation of the same moving average. In addition, the current average price is the average value at the time of the comparison. In spite of this, the standard deviation is the measure of how much a value fluctuates from its average. Bollinger Bands are plots that are above or below the moving average. They are based upon standard deviation.

“Simple Moving Average” (SMA), is the average price for a specific period. So, it is used to determine the trend’s direction.

The bands will typically be set at two standard deviations below and above the 20-day moving mean.

A trend is formed when the bands become tighter or closer together. Furthermore, this can be seen by chartists. An investor might buy the security to track the trend upwards if the trend is positive. Investors would sell if the distance between bands increases. In spite of this, if the moving average is not within one of the bands, the strength of the trend will be quite strong.

Average Volume

The average volume is simply a moving average of all shares traded during the specified time period. You can calculate, for example, the average daily volume of the 60 preceding days.

If the volume is higher than the average moving volume, it indicates a stronger trend. If the price is rising and the volume is higher than the average volume, it is a sign that there is a strong trend. Investors might decide to buy or increase their stock. The trend is considered weaker if the volume is lower than the average moving volume.

MACD

The “Exponential Moving Average” (EMA), is similar to the simple average except that it places more weight on current data.

The MACD line can be approximated by subtracting the 26-period exponential moving average from the 12-period exponential moving average and plotting its value. In addition, the MACD can be used to approximate a signal line. This is the nine-period exponential line that represents the MACD line.

An investor who uses this indicator to buy security would purchase it if the MACD line is above the signal line. Furthermore, an investor might consider selling if the MACD line drops below the signal line.

Alternatives to Technical Analysis

Fundamental analysis can also be used to evaluate investment decisions. You can use it by itself, or with technical analysis.

Fundamental analysis is based on the company’s value to investors and not historical stock price trends. Fundamental analysis requires data such as the value of assets, debt, and operational performance, such as profitability and cash flow. These data can be gleaned by reviewing the financial statements for the quarters and the year, which include the income statement, balance sheets, and cash flow statement.

Technical Analysis vs. Fundamental Analysis

Technical Analysis

• Market activity is the basis for market decisions
• Relies on charts

Fundamental Analysis

• Company data is used to inform decisions
• Relies on financial statements