Technical Analysis- Analyzing securities for Investments
Posted in Finance Articles, Total Reads: 2905
, Published on 12 March 2012
There are two methods used to analyze the securities and make investment decisions: fundamental analysis and technical analysis. Fundamental analysis involves analyzing all the data available other than the price action to determine whether a company is over, under or correctly valued. Technical analysis takes a completely different approach; it is not concerned with the "value" of a company. Technicians focus purely on the price movements in the market.
Technical analysis really just studies demand and supply in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components.
Technical analysis does not attempt to measure a security’s intrinsic value, but instead uses charts and other tools to identify patterns that can suggest future activity.
Art over science
Fundamental analysis requires us to perform a great deal of mathematical operations to generate an answer. Technical analysis does not. Looking at the same chart, many investors will derive different answers. Therefore, reading charts evolves into an art form where each analyst can provide a unique insight.
There are many different types of technical traders. Some rely on chart patterns; others use technical indicators and oscillators, and most use some combination of the two. In any case, technical analysts' exclusive use of historical price and volume data is what separates them from their fundamental counterparts.
The field of technical analysis is based on following assumptions: 1.The market discounts everything 2. Price moves in trends 3. History tends to repeat itself
1. The market discounts everything
Technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company – all the fundamental, political, macro and micro economic data.
Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.
2. Price moves in trends
In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on thisassumption.
3. History tends to repeat itself
Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to the psychology of trading and human nature in general. Pride, greed, hope, anger, sadness and ego are all factors that affect the market place as much as they do in our normal lives. In other words, market participants tend to provide a consistent reaction to similar market situations over time.
Not Just for Stocks
Technical analysis can be used on any security with historical trading data. This includes stocks, futures and commodities, fixed-income securities, forex, etc. In fact, technical analysis is more frequently associated with commodities and forex, where the participants are predominantly traders.
If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.
In the next article I will focus on type of charts used in technical analysis.