Technical analysis of stocks is gaining popularity amongst investors and traders as advancements in charting patterns, and trading platforms are making it easy for investors to use this method for security analysis. However, for an amateur investor, understanding technical analysis of stocks can be intimidating and challenging.
Stock market technical analysis is a method used to examine the price movements of stock by studying the historical charts and specific indicators and determine the future price of the stock. Quite simply, it is analyzing the pictorial representation of the past and present price movements and using it establish patterns and identify the trend for the future price of the stock. As opposed to fundamental analysis, which analyses a stock based on its intrinsic value and impact of external factors on the price of the security, technical analysis of stocks is purely based on identifying patterns on a chart to determine the future price movement.
Key assumptions for technical analysis of stocks
Technical analysis is based on studying the market action and the function of demand and supply of the stock. Few key underlying assumptions are:
- Believes in the theory of the efficient market and reflects all information
The first assumption of technical analysis of stocks is that the current market price of the security reflects all the information and it is the fair price of the stock and should be the basis of analysis.
- The price movement of stock follows a trend
The price of the stock moves in a trend until reversed. So, analysts need to identify the trend by reading the price pattern.
- Patterns repeat itself
The beauty of technical analysis of stocks is that close monitoring of the charts reflects the same patterns being repeated hence making it easier to predict future price movements.
Chart Analysis
To perform technical analysis, you need to use charts to identify trends and also any reversal in trend. These technical analysis charts are a visual representation of the price of the security over a period. The vertical axis is the price scale, and the horizontal axis is the time scale.
The three important technical analysis charts are-
- Line charts- It is formed by connecting the closing price of the stock over a specific period and does not include any other information like open, high, or low of the stock.
- Bar charts- Bar charts provide a better visual of the price of the stock as it shows the opening, high, low, and closing (OHLC) of the stock.
- Candlestick charts- The candlestick chart provides the same information as bar charts, but the representation makes candlesticks charts easier and quicker to understand.
Technical Analysis Indicators
Indicators are the basis of technical analysis of stocks and play an important role in helping analysts in identifying trading opportunities by giving entry and exit signals in the stock markets. These technical analysis indicators broadly fall in two categories-
Leading Indicators –These lead the price movement and indicate the probability of trend reversal in advance. Some of the common leading indicators are the Relative Strength Index(RSI), Stochastic Indicator, etc.
Lagging Indicators- These follows the price movement and are trend-following indicators. Some of the common lagging indicators are moving averages (MA), moving average convergence/divergence (MACD), etc.
- Trend line indicator
This is one of the simplest indicators used in technical analysis and is important to identify the market trend. The price movement of a stock is represented in peaks and troughs series, and these series represent the trend in which the price moves. The three market technical analysis of stock trends are-
- Uptrend- Uptrend is defined as a series of higher highs and higher lows
- Downtrend- Downtrend is defined as a series of lower highs and lower lows
- Sideways- The market is said to be flat when the prices move in a horizontal range.
Using trend lines is one of the many techniques for analysis, and once the then trend line is broken, it should be used as a warning for a reversal in trend. Once there is a breakout in the trend line additional tools should be used to identify the change in trend.
- Supportand Resistance Indicators
Support and resistance levels are two critical levels that define the meeting point of the forces of demand and supply and help analysts determine the market psychology.
Support – It is the level where the demand is strong to keep the security from sliding any further.
Resistance- It is the level where the supply is strong to keep the stock from moving any higher.
When either of the levels is broken, then the supply and demand have moved on, and new support levels will be established.
- Momentum Indicators
Momentum indicators are usually leading indicators and tell you how strong the current trend is and if the trend is likely to change. Some of the common momentum indicators include
- The moving average convergence/divergence (MACD) indicator- It shows the relationship between two moving averages.
- Relative strength index indicator- It measures the speed and strength of the price movement in the market by comparing the current price to the past performance.
- Oscillating Indicators
Oscillating indicators are used for the analysis of securities that are not trending but are trading in a range. Oscillating indicators are beneficial when the security is moving in a horizontal pattern and discover potential entry and exit points as they help determine oversold and overbought conditions. A Stochastic oscillator is the most frequently used indicator.
The above indicators are significant for analysts and traders for technical analysis of stock trends and for future price movement prediction.
CONCLUSION
For anyone who is trading or investing in the equity markets, it is important to understand the basics of technical analysis to understand the market movements. However, as stock market technical analysis is a little complex, correct guidance is essential. Our experts at IndiaNivesh can help you guide through the crucial tools and techniques for technical analysis.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
Ref: https://www.indianivesh.in/kb-blog/how-to-perform-technical-analysis-of-stocks
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