Sunday, September 8, 2013

An Introduction to Technical Analysis

Technical Analysis is a study of mass psychology. It is partly a science and partly an art.


Individual behavior is complex, diverse, and difficult to predict. Group behavior is primitive.Fundamentals, while important, do not help the stock trader assess risk and timing issues in the present and now.

This is where technical analysis documents, stock analysis and stock market charts outshine the fundamentals. However, both disciplines can be used to compliment each others strengths.

By definition, technical analysis is a way of forecasting price movements through trend analysis of price movements. Generally, there are a lot of technical indicators that are being used by technicians to determine a stocks's next move.


Technical analysis, by theory, doesn't care completely about what company it is or even its earnings reports. The stock market is driven by belief and expectations of investors. So basically, price charts reflect or show the investors sentiment on a certain stock. Through charting, you will be able to determine when and how you'd get in and out of a stock base from the trends that charts show.

Technical analysis is all about studying stock price graphs and a few momentum oscillators derived thereof. It is the forecasting of future financial price movements based on an examination of past price movements. It is a security analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume.

It must be understood that technical studies are based entirely on prices and do not include balance sheets, P&L accounts (fundamental analysis), the assumption being that the markets are efficient and all possible price sensitive information is built into the price graph of a security / index.

Like weather forecasting, technical analysis does not result in absolute predictions about the future. Instead, technical analysis can help investors anticipate what is "likely" to happen to prices over time. Technical analysis uses a wide variety of charts that show price over time.

Behavioral economics and quantitative analysis use many of the same tools of technical analysis, which, being an aspect of active management, stands in contradiction to much of modern portfolio theory. The efficacy of both technical and fundamental analysis is disputed by the efficient-market hypothesis which states that stock market prices are essentially unpredictable.

One of the basic essential concepts of technical analysis are the support and resistance concept. Support means that based from the chart, stock prices does not go below this level. Meaning to say, there are less likely chances that a stock price would go below this level. But when it does, this is called a break below and this suggests that prices would continue to go lower until the next support.

On the other hand, the term resistance is the opposite of the support. Resistance resembles a ceiling of a certain stock's price. Just like the support, if it breaks out its resistance line, this now suggests prices would now go up from that level; the resistance line now becomes the support.

Personally, the indicators that I use are very basic like MACD, Stochastic Oscillator, RSI, and Volume. This should be enough to get you started to know when to get in and get out of a stock.


Therefore, technical analysis supports the efficient market theory as against the "random walk theory" which supports the belief that stocks can be bought / sold on random events like flipping a coin!!! Technical analysis is more dynamic as compared to fundamental analysis based on one simple argument - fundamental analysts depend on corporate events like quarterly results and special announcements like earnings guidance and policy changes in operations to generate a buy / sell recommendation. 

If fundamental analysis was the single most reliable indicator of trends, prices would predominantly fluctuate only 4 - 5 times a year - around quarterly results and special announcements like mergers and acquisitions etc!! Why would prices fluctuate almost daily? If the prices fluctuate ever so often, is there a way to forecast them? Yes according to technical analysis!!

Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand. Price refers to any combination of the open, high, low, or close for a given security over a specific time frame. The time frame can be based on intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data and last a few hours or many years. In addition, some technical analysts include volume or open interest figures with their study of price action.

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