Technical Analysis is the method of evaluating securities by analysing statistics developed by market activity, such as historic data and volume. Technical analysis generally does not involve the measure of a security’s intrinsic value as mentioned above, but rather uses charting tools to identify patterns to forecast future activity.
The technician looks at day to day or week to week price changes or over a constant time period in the form of graphs or charts and examines price action in securities as opposed to fundamental factors.
Technical analysis usually reflects the trends, momentum and patterns that repeat over time, this process may not be exact but history proves it to be similar. Charts usually reflect the psychology or mood of the crowd and not the fundamental factors thus technical analysis can be deemed the analysis of human mass psychology.
Understanding human psychology and emotion is vital in the stock market, fear and greed often overwhelms investors and is often the reason why investors do not make money in the market. Knowing when to buy and when to sell is equally important and the use of technical analysis is to attempt to identify these issues.
Investors who manage to act opposite to the mood of the crow and against their own emotions are best positioned to earn money in the stock market which is why having the right advisor is equally important to knowledge and information.
The purpose of technical analysis is to identify trend changes that precede the fundamental trend and do not make sense if compared to the concurrent fundamental trend.
The above chart shows that if investors buy based on confidence or optimism they buy near or at the top of the trend line. Inversely investors are also fuelled by fear and pessimism and sell near or at the bottom.
However when looking at the above chart from a fundamental analysis approach if you are investing in a fundamentally sound company which is below its intrinsic value then purchasing a security at the “panic/fear/pessimism” stage would be seen as a good mid to long term investment.
The importance of knowing when to invest in a security and knowing when to sell is crucial to success in the stock market, which is what technical analysis attempts to achieve.
Key concepts of Technical analysis:
- Resistance — are levels or horizontal lines that start at a recent extreme price peak with line pointing horizontally into the future.
- Support — are levels that start at a recent extreme of a correction low point, generally speaking a level where a security is supported and usually prompts increase of buying.
- 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.