What is meant by technical analysis?
Technical analysis is based on the assumption that all information that can affect the performance of a stock is reflected already in its stock prices. Technical analysts approach is to forecast the direction of prices through the study of patterns in historical market data, price and volume.
Technicians believe that market activity will generate indicators in price trends that can be used to forecast the direction and magnitude of stock price movements in future.
How a trader or investor can use this tool ?
- To check the overall trend
- To check strength of the trend
- To check maturity of the tend
- To check reversal signal of the trend
- To check the next trend
Here trend is common which means technical analysis is all about analyzing the trend. Basically this is a demand and supply story.
Difference between technical and fundamental analysis :
Fundamental analysis involves determining the intrinsic value of the stock and comparing it with the prevailing market price to make investment decisions. Fundamental analysts believe that prices will move towards their intrinsic value sooner or later.
Technical analysis is not concerned whether the stock is trading at a fair price relative to its intrinsic value. It limits itself to the future movements in prices as indicated by the historical data. It is used for short term trading activities and not necessarily long term investing.
Advantages of technical analysis :
Technicians feel that a great deal of information is lacking in financial statement. They also feel that a lot of non-financial information and psychological factors do not appear in the financial statements.
Technicians also feel that unlike fundamental analysts, they do not need to collect information to derive the intrinsic value of the stocks. They only need to quickly recognize a movement to a new equilibrium value for whatever reason. Hence, they save time in collecting enormous information which is essential for fundamental analysis.
Data required for technical analysis :
- Open price
- Close price
- High price
- Low price
- Volume
- Open interest
These are the base data required for analyzing any stock or index.
Accumulation and Distribution :
Breakout or breakdown takes place after accumulation or distribution.
Accumulation is change of stock ownership at a gradual rate from weak hands to strong hands. After accumulation more people chase lesser number of stocks resulting in higher price. That is demand for the stock increases which result in higher price.
Distribution is change of ownership at a gradual rate from strong hands to weak hands. After distribution weak hands who generally have lesser capacity to hold on to their stock are left with more number of stocks. In a way supply of stock increases with lesser number of takers which results in lower price.
Conclusion :
Technical analysis is a good option not only for short term trading but also for investment purposes. It helps traders or investors in making right entry and exit and also saves a lot of time.
But it has some limitations as well such as it is not necessary that it works perfectly all the time. For medium to long term investment, a combination of fundamental analysis with technical can create magic.