There is an old saying, "History Repeats Itself". Technical Analysis (or TA) is more or less based on this philosophical principle. TA majorly deals with analyzing the charts of securities like stocks, currencies, commodities, etc to identify the trends and patterns and draw conclusions to predict a future price level.
By definition, “Technical analysis is a means of examining and predicting price movements in the financial markets, by using historical price charts and market statistics. It is based on the idea that if a trader can identify previous market patterns, they can form a fairly accurate
prediction of future price trajectories.”
While there is a common notion that technical analysis is riskier and only used by traders, it is also used by long term value investors to determine their entry and exit price levels and validate their findings from the Fundamental Analysis. Technical Analysts use charts belonging to various time ranges like minute charts, daily, monthly and weekly charts.
It has always made me curious about how these price charts help analysts predict prices? What are the underlying dynamics that are in place that makes these predictions reliable and accurate if done correctly? The stock markets run on the confidence and emotions of the investors, and this confidence is usually reflected by the prices. For example, a confident market would bring the price up while an opposite one would drive them down. Such a swing of sentiments and other factors follow a trend and a cyclical pattern. Technical analysis tries to identify such trends and patterns and extend them for future periods to find the expected behavior of the stock market. Hence, it is widely accepted that TA follows the Pareto Principle where the market runs 80% on the psychology and 20% on the logic of the players of the market.
What are the tools for Technical Analysis?
TA is not plainly looking at the price chart and trying to predict what the next price level will be. It involves a lot of analysis based on various laws and principles using different tools. Some of the tools used in TA are
- Line charts, Bar Charts and Candlestick Charts, Heikin Ashi Charts
- Trend lines
- Moving averages
- Cyclical chart patterns
- Price indicators
- Fibonacci ratios and levels
- and a lot more...
While analyzing a stock, more than tools are used in order to come to reliable conclusions. While some tools are just a substitute of the other, they are used to validate the findings of the other tools.
Why is it used so widely?
TA may not be backed by the fundamental logic but it has been widely used in the market and there are a few reasons for that.
Firstly, TA is easy to learn however it requires patience and practice to get a grip. Next, TA can be used to predict the prices of all the securities may it be stocks, commodities, or currencies. Lastly, TA is used to fulfill the following needs:
To get an alert: TA helps in defining stop-losses when the chart is about to break a trend helping us to minimize our losses.
To get a confirmation: TA indicators can be used to confirm findings of various charts and also fundamental analysis
To predict the prices: Finally, it helps in predicting the movements of prices in the next time period.
However, there are a few things that a beginner or a Techincal Analyst has to keep in mind before completely relying on such an analysis:
TA is subjective in nature, i.e. different analysts may use different indicators to come to different conclusions.
TA is a bit complicated, Analysts at times use too many indicators and tools and get conflicting results in many of them, hence a wise choice of indicators should be made depending on the economic and industrial scenario.
TA may give late signals, By the time an analyst catches a trend, a substantial move within or outside the trend has been already made reducing the risk-reward ratio.
How to conduct Technical Analysis?
While we have known the whats and whys of TA, it takes time to explain and learn how such an analysis is undertaken. Further blog posts on TA will help you know what are candlestick charts, line charts, bar charts, and much more.
Stay tuned for another update!
P.S. If you come across queries in understanding any concepts, feel free to reach us out via mail, Instagram, or Twitter!
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