Technical Analysis

While fundamental analysts examine earnings, dividends, new products, research etc., technical analysts examine investor fear or what investors think about certain developments in the market and whether or not investors have the wherewithal to back up their opinions; these two concepts are called psych (psychology) and supply/demand.

Technicians employ many techniques, one of which is the use of charts. Using charts, technical analysts seek to identify price patterns and market trends in financial markets.

Technical analysts fall in to the other category where in they believe that the past performances of a stock indicate its future performance. Technical analysis is a science of forecasting the direction of prices through the study of past market data, primarily price and volume. The principles of technical analysis are derived from hundreds of years of financial markets data.

Principles of Technical Analysis

 1. Stock Price reveals Everything – Anything upcoming – Good results, bad results, strategic decisions, management decisions, dividend, buybacks or anything else, will always be reflected in stock price.

Technical analysts believe it is important to see how market will react on any news and also that the stock price will give clearer picture about the news than the news itself. Technical analysts do not prefer digging into the news and try to understand how it will affect the stock price but they try to understand the news based on the stock price movement.

2. Stock price move in trends – If a stock is following a trend (uptrend or downtrend or bullish or bearish trend), it would continue to follow the trend (unless trend reversal patterns are formed) for some more time.

3. Pattern repeats itself – There are certain set of events that occur on a regular basis in the market and if a pattern is formed with those set of events, the price pattern would repeat yet again when those chain of events repeat.

Despite all the fancy and exotic tools it employs, technical analysis primarily deals with the demand and supply in the market in an attempt to determine the direction, or trend, in the foreseeable future.

In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components.

If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.

When to use Technical Analysis

Fundamentals of the company help to decide the strength of the company and  its shares whereas technical analysis will help in selecting the right time to enter in the company stock so that u get the stock at the right price of a good company.

We, at WealthCity, use a host of technical charting tools to identify patterns that can suggest future activity.

Some of them are ADX, Parabolic SAR, CCI, Directional Movement Index, Trend Locator, MACD etc. A sample of the chart is shown below:

 

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Charting terms and indicators

Concepts

  • Resistance — a price level that may prompt a net increase of selling activity
  • Support — a price level that may prompt a net increase of buying activity
  • Breakout — the concept whereby prices forcefully penetrate an area of prior support or resistance, usually, but not always, accompanied by an increase in volume.
  • Trending — the phenomenon by which price movement tends to persist in one direction for an extended period of time
  • Average true range — averaged daily trading range, adjusted for price gaps
  • Chart pattern — distinctive pattern created by the movement of security prices on a chart
  • Dead cat bounce — the phenomenon whereby a spectacular decline in the price of a stock is immediately followed by a moderate and temporary rise before resuming its downward movement
  • Elliott wave principle and the golden ratio to calculate successive price movements and retracements
  • Fibonacci ratios — used as a guide to determine support and resistance
  • Momentum — the rate of price change
  • Point and figure analysis — A priced-based analytical approach employing numerical filters which may incorporate time references, though ignores time entirely in its construction.
  • Cycles — time targets for potential change in price action (price only moves up, down, or sideways)
  • Market Condition — the state of price movement as being in a state of range expansion or a range contraction.

Types of charts

  • Open-high-low-close chart — OHLC charts, also known as bar charts, plot the span between the high and low prices of a trading period as a vertical line segment at the trading time, and the open and close prices with horizontal tick marks on the range line, usually a tick to the left for the open price and a tick to the right for the closing price.
  • Candlestick chart — Of Japanese origin and similar to OHLC, candlesticks widen and fill the interval between the open and close prices to emphasize the open/close relationship. In the West, often black or red candle bodies represent a close lower than the open, while white, green or blue candles represent a close higher than the open price.
  • Line chart — Connects the closing price values with line segments.
  • Point and figure chart — a chart type employing numerical filters with only passing references to time, and which ignores time entirely in its construction.

Overlays

Overlays are generally superimposed over the main price chart.

  • Resistance — a price level that may act as a ceiling above price
  • Support — a price level that may act as a floor below price
  • Trend line — a sloping line described by at least two peaks or two troughs
  • Channel — a pair of parallel trend lines
  • Moving average — the last n-bars of price divided by “n” — where “n” is the number of bars specified by the length of the average. A moving average can be thought of as a kind of dynamic trend-line.
  • Bollinger bands — a range of price volatility
  • Parabolic SAR — Wilder’s trailing stop based on prices tending to stay within a parabolic curve during a strong trend
  • Pivot point — derived by calculating the numerical average of a particular currency’s or stock’s high, low and closing prices
  • Ichimoku kinko hyo — a moving average-based system that factors in time and the average point between a candle’s high and low

Price-based indicators

These indicators are generally shown below or above the main price chart.

  • Average Directional Index — a widely used indicator of trend strength
  • Commodity Channel Index — identifies cyclical trends
  • MACD — moving average convergence/divergence
  • Momentum — the rate of price change
  • Relative Strength Index (RSI) — oscillator showing price strength
  • Stochastic oscillator — close position within recent trading range
  • Trix — an oscillator showing the slope of a triple-smoothed exponential moving average
  • %C — denotes current market environment as range expansion or contraction plus highlights ta extremes when the condition should be changing.

Breadth Indicators

These indicators are based on statistics derived from the broad market

  • Advance Decline Line — a popular indicator of market breadth
  • McClellan Oscillator – a popular closed-form indicator of breadth
  • McClellan Summation Index – a popular open-form indicator of breadth

Volume-based indicators

  • Accumulation/distribution index — based on the close within the day’s range
  • Money Flow — the amount of stock traded on days the price went up
  • On-balance volume — the momentum of buying and selling stocks