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Beginner’s Guide to Technical Analysis

Master the art of market forecasting with technical analysis.

In our other writeups, we have mentioned that there are generally two kinds of approaches that investors took in order to choose the stocks that will be a part of their portfolio. Their evaluation methods usually revolve around value investing or technical investing.

Value investing is where you look into the company’s intrinsic values, i.e., by digging into the company’s details, like balance sheets, contracts secured, and more. Technical analysis is where they wouldn’t really care much about a company as an individual, but rather the data that is available on the company.

As of now, let’s dig into technical analysis in a bit more detailed manner.

Find out more:

Types of Stock Trading Strategies

What is technical analysis?

Technical analysis is an approach where investors will study historical market data to predict price movements. In doing so, they would usually study subjects like behavioral economics, quantitative analysis, and market psychology.

Simply, technical analysis is where investors or traders will look at market data (such as price movements and volume). From that data, they will process it using whatever methods they choose to use. Once they processed the data, they will figure out a certain pattern in the market, so they know when they want to place their buys.

Technical analyses are usually done to see if a certain trend in price movement will either continue to move that way or reverse in the opposite direction.

Core principles in technical analysis

The usual core tenets of technical investors are:

The market would usually reflect all available data.

 

Simply, this principle believes that whatever price you see on, say, stocks right now is the price that has taken into account almost every aspect of the market.

For example, if you see the stock of Company ABC falling down from $2 to $1.5, what many technical investors will say is that the fall has taken into account every angle of the market. Even if the price should’ve been higher, a technical investor would consider the fall to be a proper reflection of the market — perhaps it’s due to investors being emotional, or there is any other information that may lead to the fall.

Market tends to repeat itself.

 

Another core tenet that technical investors usually hold on to is that the market tends to repeat itself. Many creatures on this earth are blessed with the ability to recognize patterns in nature.

The market is no different. There is usually a certain pattern that can be seen, perhaps from previous and current stock price movements that are somewhat familiar enough for you to guess what’s coming up next.

How technical analysis is done?

As for the ways that they do their analyses, there are many such ways, but the two most common ones are:

1. Chart patterns

 

Some technical investors will study and look for a certain pattern in charts. How it works is that based on the belief that the market tends to repeat itself, they will look for certain patterns that are usually repetitive in nature — for example, when the chart moves like this and that, the price trend will usually continue.

Under this method, investors would usually look for a “level of support” in the chart, which is a calculated price — sort of like a line — whereby if the line is crossed, it indicates that it’s either a time to buy or sell.

It’s almost like how sailors back then used stars to navigate their way through their voyages. Of course, stars are more predictable than the market — but a certain pattern would often repeat itself.

Dive deeper:

Basics of understanding stock chart patterns

 

2. Technical Indicators

 

Another way that is most used by a technical investor is technical indicators. This is usually where they will apply statistical formulas on data like price or volume to create a projection of how the price might go.

Here are a few indicators you might be interested in:

  • Trend lines.
  • Volume
  • Moving Average
  • Bollinger bands
  • Darvas box
  • Exponential Moving Average
  • Moving Average Convergence Divergence
  • Relative Strength Index
  • Volume-weighted average price

Now, on the thought process that usually goes on during this analysis process:

 

1. Top-down

 

Top to bottom is where analysis is done by looking at the macroeconomics of a market first. This can be done by looking at things like global trends and price movements, volume, etc.

Once they find a specific economy that is performing better than the others, the scope will then move to a particular market, such as by looking into trends in an index like the S&P 500, or by looking at industrial performance. After that is done, then will the analysis be done on the micro-level, by looking into the company within the selected performance.

This is usually done to analyze larger time period trends, and it can be useful if you want to look for economies, market classes, or sectors that outperform the general performance of other macro-level factors.

2. Bottom-up

 

This method is where analysis is usually done by looking at any specific asset, such as a company’s stock that is performing well relative to its peers. After they are done with looking for assets that are performing well, they will then widen the scope of their analysis to a macro-level, by looking at the performance of the sector, or the market as a whole.

When that is done, they will try to see if the stock performance is dependent on the market performance, but bottom-up analysts usually hold on to the belief that assets perform individually — that is to say, even if the market is bad, the good asset will be able to perform well.

The bottom-up method can be useful if you are looking for a specific asset (stocks, bonds, currencies, etc.) that outperforms its peers.

Technical vs Fundamental analysis

This is not everything, but here are a few of the most outstanding differences between technical analysis and fundamental analysis.

Bottom line

  • Technical analysts believe in two things: The market price of an asset has already reflected every single piece of data available to the market, and patterns tend to repeat themselves.
  • The two most used methods are: looking into chart patterns and looking at technical indicators.
  • This method is usually quicker, while fundamental analysis takes more time for their due diligence process.
  • Technical analysis is usually used by short-term to medium-term investors, but it can also be used for long-term investing purposes.

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None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.

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