Stock Market Technical Analysis for Traders and Investors

Stock market technical analysis is the charting method of analyzing securities. Price and volume are strictly driven by demand and supply, also forming the future trend.

Stock market technical analysis in one of the two most common methods used to analyze securities before making investment decision; the other main school is known as fundamental analysis. Fundamental analysts are focused on estimating fair company value from financial statements (balance sheet, cash flow statement and income statement) and trying to figure out if the stock is under or overvalued compared to its intrinsic value and act accordingly (if the stock is undervalued the suggest buying it and in case it is overvalued the preferred action is to sell the stock).

Technicians (or often called chartists) on the other side take totally different approach; they don't care about the fair value of the company, since they believe in market efficiency. Therefore chartists are only focused on historical price movements of the security - they analyze charts using different indicators - and based on that information they try to figure out what is the most probable scenario of stock movement in the future. Proper risk management is one of the most important topics of stock market technical analysis.

Many investors don't take technical analysis seriously enough in the beginning stages of trading or investing; many don't believe that it is possible to predict the future based just on the historical price patterns, others think it is to simple to be true compared to fundamental analysis. But if you will learn about technical analysis to advanced level, you will find out that analyzing chart in not only looking at stock historical price movement and guessing what can happen - it is in depth research of supply and demand in the specific market, which determine the direction or trend of price movement in the future; remember, stock prices are driven up and down based on supply and demand only! Of course, there are different factors influencing the supply and demand and understanding them will help you understand the benefits and limitations of stock market technical analysis better.

Let me get one more thing very clear at the beginning - the purpose of technical analysis is not to predict the market! Chartist are only looking for the most probable scenario of future price movement; since nobody (neither fundamental analysts) really knows in which direction the markets will go, technicians swear on disciplined approach and always protect themselves in case they were wrong. It is very interesting how stock market technical analysis is gaining on its credibility lately - all the major brokerage houses are employing technicians. Could be because of the last financial crisis, when fundamentals totally disappointed?

What Is Stock Market Technical Analysis?

Stock market technical analysis is analyzing historical market activity, which is plotted on charts as price and volume - analyzing price and volume on the charts in combination with some other tools help technicians identifying patterns suggesting future activity.

Technical analysis can be very simple or extremely complicated. I prefer the KISS approach (keep it super simple):

  • I to identify trend and trend channels with help of a few simple moving averages.
  • I focus on identifying support/ resistance areas in the security with drawing the lines on the chart price.
  • I always include volume data research next to the price to give me the filling about the power of information.
  • Occasionally I add Fibonacci sequence analysis or some simple indicators and oscillators next to overall research (like RSI, MACD, and momentum for example).

Stock market technical analysis can be applied to any type of asset class: bonds, stocks, futures, commodities, forex, etc. and any type of securities, as long as it has sufficient historical trading data and high enough liquidity. Higher liquidity brings better results to technical analysis.

Regarding the time horizon, technical analysis is predominantly used by short-term oriented traders and less by long-term investors. While fundamentalist are focused on a number of years, the chartists are oriented on a timeframe of weeks, days or even minutes. Still, even long-term investors use stock market technical analysis for more precise determining of the best possible entrance or exit points.

It is not only the time horizon where technical stock market analysis is different than fundamental - it is also about the main goal of security purchase or sell. Traders, who enter the position based on idea to sell it to somebody else at better price, much more rely on technical analysis. Investors, who enter the position because the stock is undervalued and exit because it is overvalued, much more rely on fundamental analysis. Thaw, it is often difficult to distinguish trading and investing.

The Basic Assumptions Of Stock Market Technical Analysis

Technical analysis concept is build upon the following assumptions:

  • Efficient market hypothesis (EMH) which assumes that stock price reflects all available information in every moment, including fundamental factors, broader economic factors and market psychology, thus suggesting it is not necessary to research and analyze these areas separately.
  • Securities prices always move in trends and suggesting that when the trend is established, it is much more probable that the stock price will move further in the direction of the trend than against it.
  • Because of market psychology the history is repeating itself, especially in terms of price movement. Participants in stock market tend to react similarly to same market situations over time.

Fundamental And Technical Analysis Hand In Hand

Although both approaches are based on different assumptions and have many critics, it is very common that professionals started combining both methods in their investment decision process. For example, a fundamental analyst is nowadays using also technical analysis for figuring out the best time to enter into undervalued stock and therefore improving the gains on investment. Alternatively, technical analyst is nowadays also looking for fundamental data to add the power of technical signal. Combining both analyses together can provide you the best-case scenario for the trade, even if this is not well received by the most devoted groups in each school.

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