Technical analysis is a tool to study historical market data to predict stocks future price movement. It is a research technique which we use to analyzed a stock based on their historical performance in market. The most common method we use in technical analysis is price action, chart pattern and Indicators.
Why we use technical analysis?
Everyone wants to make profit from market from day 1. And only one thing that can help to make that happen is the understanding of technical analysis. There are many ways and strategy to find a good stock for trading, but technical analysis is one of the most used and successful technique for trading.
Unlike fundamental analyst, technical analyst don’t worry about company valuation. They do not look into company balance sheet, profit and loss, cash flow statement like fundamental analyst do. The only thing that matters is the stock historical trading data ( price and volume) and the insight the past data provide about the future movement in stock price
Key concepts and tools used in technical analysis:
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Price Charts: Imagine a graph that shows how the price of something (like a stock) has changed over time. Analysts use these charts to spot patterns or trends. The most common types of charts are line charts, bar charts, and candlestick charts. These charts help analysts identify patterns, trends, and potential reversal points.
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Trends: Think of trends as the general direction in which the price is moving. Trends can be upward (bullish), downward (bearish), or sideways (consolidation). They help traders identify potential entry and exit points for trades.
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Support and Resistance: Picture a bouncy ball. When the price drops to a certain level and bounces back up, that level is like a floor (support). When it reaches a high point and bounces down, that’s like a ceiling (resistance).
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Indicators: These are mathematical calculations based on historical price and volume data. Examples include moving averages, Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Bollinger Bands. Indicators help traders identify overbought or oversold conditions and potential trend reversals.
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Patterns: These are recurring geometric formations on price charts that technical analysts believe can indicate potential future price movements. Examples include head and shoulders, double tops and bottoms, and flags.
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Volume: Imagine the sound of people trading. If a lot of people are buying or selling, it can indicate the strength or weakness of a price trend.
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Fibonacci Retracements: This technique involves drawing horizontal lines on a price chart at key Fibonacci levels (38.2%, 50%, and 61.8%). These levels are used to identify potential support and resistance levels during price retracements within a trend.
Also Read: Option trading for beginners
Technical Analysis : Assumptions
When it comes to market overall psychology technical analyst believes that price moves in trends and history tends to repeat itself. These are the assumptions that every trader follow.
Example: Imagine you’re looking at the price chart of a stock that has been consistently going up over the past few months. According to the assumption of technical analysis, if the stock has followed a certain pattern during previous upward movements, it might repeat a similar pattern in the future.
For instance, you observe that every time the stock price increased by a certain amount in the past, it tended to experience a temporary dip before rising again. As a technical analyst, you might expect that if the stock price increases by a similar amount in the future, it could follow the same pattern—a temporary dip followed by another increase.
In this way, technical analysts use historical price behavior to identify patterns and trends, making predictions about potential future movements based on the idea that market psychology and investor behavior tend to repeat over time. It’s important to note that while this approach can be insightful, it’s not foolproof, and other factors can influence market movements.
In short, technical analysis is like reading the story of a stock or asset by looking at its past behavior, hoping to make informed guesses about its future movements. Keep in mind, though, that it’s not a guaranteed method, and other factors like news or world events can also influence prices.