What is technical analysis and how can you do it?
Before trading or investing in the stock market, we’d highly recommend you properly research on the stocks you want to buy. There are two primary methods to research and analyze securities, and make investment decisions: fundamental analysis and technical analysis. Which one you choose depends on your expertise and ease of understanding. Here, in this article, we will try to understand technical analysis and how you can perform it. You will be pretty clear about technical analysis after we complete this article, and with some practice you will be good to go.
- There are two primary methods to research and analyze securities, and make investment decisions: fundamental analysis and technical analysis.
- In technical analysis, you have to evaluate securities by statistically analysing market data such as price and volume.
- Fundamental analysis instead looks at economic and financial factors that influence a business.
What is technical analysis in trading?
Technical analysis is quite similar to the basic principles of economics, such as analysis of supply and demand in the market, to determine where the price trend is headed. In technical analysis, you have to evaluate securities by statistically analysing market data such as price and volume. You use charts and various other tools to understand different patterns. As a technical analyst, you depend on these patterns to help you make investment decisions. You should not be concerned with the valuation of the stock, but rather be concerned about past trading data only.
Some basic assumptions of technical analysis:
- The market price accounts for everything: Fundamental analysts criticize technical analysis because of the fact that it only considers price movements and totally ignores fundamental factors such as political impact. However, technical analysts counter this criticism by stating that a stock’s price already reflects everything that has or could affect a company. So this removes the need for you to be concerned about fundamental factors. The only thing you should be concerned about is the analysis of price movement.
- Prices move in trends: By the assumption of technical analysis, prices move in short-, medium-, and long-term trends. The stock you pick for analysis will follow the same past trend, rather than move randomly.
- History tends to repeat itself: The third assumption is that the market history tends to repeat itself. It is believed that the repetitive nature of the price movements is due to market psychology. You will have to use chart patterns and historical data to analyze these emotions and understand market trends. While technical analysis has been used for more than a 100 years, it is still relevant because stocks follow patterns in price movements that often repeat themselves.
Difference between technical analysis and fundamental analysis:
Now we know that technical analysis uses past data of a stock to predict future price movements. Fundamental analysis instead looks at economic and financial factors that influence a business. So, let’s get deeper into the details of how fundamental analysis and technical analysis differ.
- Charts vs. Financial Statements: The first step in technical analysis starts with the charts, whereas in fundamental analysis it starts with the company’s financial statements. In fundamental analysis, you will have to determine a company’s intrinsic value by looking at its income statement, balance sheet, and cash flow statement. You can determine the intrinsic value of a stock by discounting the value of future projected cash flows to a net present value. If the stock trades below the company’s intrinsic value, you can invest in it. But, technical analysts believe that a stock’s price already reflects everything that has or could affect a company.
- The time horizon in fundamental analysis is often long-term, as opposed to a short-term approach taken by technical analysts. By the approach of fundamental analysis, you should wait for a long time before a company’s intrinsic value is reflected in the stock market. In technical analysis, stock charts can be delimited in weeks, days, or even minutes.
- Technical analysts and fundamental analysts have very different goals in their minds. Technical analysis will demand that you identify many short- to medium-term trades where you can earn a profit, whereas fundamental analysis demands you to make long-term investments.
- You must have gotten a clear idea about technical analysis. You can learn technical analysis strategies through videos and then practice them while trading.
- Technical analysis has been criticized by many investors, but still, it proves to be an effective technique for short-term to mid-term investing.
- You have the option of choosing one of the techniques to invest according to your need, expertise, and ease of understanding.