The fundamentals of technical analysis
A basic level of understanding of technical analysis is considered essential for anyone who invests in stocks or any other tradable financial asset. This allows traders to make better choices in terms of the degree to which they can afford to take a risk to achieve a certain amount of return. This article encapsulates the concept of technical analysis, how it works and various tools/indicators used for performing it effectively.
Technical Analysis Defined
The act of interpreting the price movement of a company’s underlying stock is known as technical analysis. Different patterns as well as price support/resistance, and range are gauged as part of technical analysis, by putting a variety of charts and statistical tools to use. Technical analysis takes into account past data to better predict a stock’s future. It is worth remembering that only the price of the shares is considered in this approach, not the business activities of the firm.
How Technical Analysis Works
Technical analysis tries to determine supply and demand by studying past price data. Investing institutions, mutual and hedge funds are factors that generally influence stock values. Technical analysis graphically illustrates the aforementioned factors by utilizing a variety of charts and indicators, and highlights price regions of significant appeal from a buyer’s as well as seller’s perspective.
A strong advantage of technical analysis is being able to discern where the divergence between a stock’s current performance and expectations about future success resides, and quantify the potential available.
Tools & Indicators Used for Technical Analysis
There are a number of techniques and indicators that may be used in technical analysis. An ideal combination of instruments may provide converging signals that increase the odds of price movement in a specific direction.
- Various Stock Charts
Technical analysis examines the narrative of a stock’s price movement to determine the underlying forces affecting the price. Using charts, it is possible to track the price where transactions have occurred. The chart options let you select the time interval of the chart. The price movement of the stock is segmented into time periods.Candlestick, bar, and line charts are some of the most popular chart kinds that provide a thorough data visualization.The candlestick charts record each segment of trading as a candle, and each candle represents five minutes of trading that records the opening price (opening candle), the highest price (high candle), the lowest price with regard to price (low candle), and the final price (close candle). A fifth data point in the candlestick chart shows the body (opening/closing price) with two distinct colors. If the last trade doesn’t exceed the first trade, the body is red in color. On the other hand, if the last trade is worth more than the first, the color of the body is green.Bar charts follow the same concept as above, except there’s no such thing as colored body in this case.
The closing prices of different time periods connected with each other form a line chart.
- Price-based Indicators
Price-based indicators are indicators that produce price-related information, such as trends, support, and resistance. Many times, a combination of those numbers will be shown and monitored on the price section of a chart. Some of the notable price indicators include trend lines, trend channels, three-line break, point and figure Moving averages, candlesticks/bars/lines, pivot points, etc.
Many analysts have observed that price trends seem to point towards a certain way. When the stock market’s price index rises in an upswing, this is called an uptrend. Conversely, in a downturn, this is referred to as a downtrend. Uptrends usually show a rise in demand for shares with more people being ready to pay more since there is less supply. A downtrend signals a large amount of shares on the market, with less purchasing demand, that consequently leads to prices lowering.
Volume is a stock statistic that encompasses all shares traded during a certain time period. This indicator may be used to judge interest that translates into major price movements. A large amount of trading activity is usually an indicator of high volume, which results in breakout or breakdown, followed by a substantial price trend. Higher trending prices lead to breakout prices and lower trending prices lead to breakdown prices. When the volume is low, the markets tend to consolidate, making it a challenging time to invest.
- Momentum Indicators
The term momentum indicator refers to an indicator that assesses a stock’s momentum. Most charting/trading systems include pre-programmed basic momentum indicators. These tools help traders timing their trades better. If traders understand when to utilize momentum indicators, they may identify overbought situations early and circumvent chasing prices. Three popular momentum indicators are stochastic, Relative Strength Index (RSI) and Commodity Channel Index (CCI).
The introduction of visual chart markings allows consumers to identify specific price support levels that often act as barriers to a price drop before giving way to a price recovery. There are also instances where price levels keep rising to reach a ceiling, ultimately forcing prices to decrease. The boundaries set by these prices are referred to as price resistance levels.
- Technical Indicators
When it comes to determining the direction of stock prices, monitoring the data points on a chart works well, however in order to discern further trends, it is necessary to do deeper data analysis. Due to the abundance of technical indicators on today’s charting and trading platforms, an amount of work that would have taken ages in the past can be completed in the blink of an eye. Indicators like moving averages linking each period’s closing price with each other can give you a graphical representation of what trends look like. Manually drawing trendlines on charts may be done using charting and trading systems. There may be various trendlines depending on the time period and beginning point of a chart, as well as individual trading preferences.
One may profitably use several indicators in conjunction with sound discipline and sound trade management to capitalize on the many opportunities available in the market. Price analysis techniques are enhanced by technical indicators.