What is technical analysis and how can you do it?

Timing is a key factor for successful trade and investment. To identify potential trading opportunities, traders use technical analysis. Smart traders use technical analysis along with fundamental analysis to enhance their trading strategies and make smart trading decisions.

What Is Technical Analysis?

Technical analysis uses technical indicators and other tools to evaluate trends and identify trading opportunities. It analyses historical price movements and trading volume to predict the future price movements of the security.

Technical analysis works by considering the following assumptions:

Markets Discount Everything

Technical analysis assumes that all known and unknown information in the public is reflected in the stock’s latest price.

Price Movements Follow Trends

It assumes that price movements follow trends, such as upwards, downwards or sideways.

History Repeats Itself

In technical analysis, it is assumed that price moves in a pattern that repeats itself over time. The price is said to follow a pattern because the market reacts to the price movements similarly each time the price moves in a certain direction.

For example, in a downtrend, traders sell their securities even at low prices due to fear of a bigger loss.

Common Technical Indicators Explained

Every seasoned trader uses the following technical indicators to enhance their trading strategies and make data-backed trades.

Support & Resistance

Support and resistance levels are used to predict price direction and breakouts. The support level is the lowest price range a security hits before going upwards. The resistance level is the highest price range a security peaks at before declining again.

Moving Average Convergence Divergence (MACD)

MACD is an indicator that helps identify trends, changes in momentum and spot potential price reversals. MACD calculates the difference between a 12-period and 26-period Exponential Moving Average (EMA) with a single line of 9-period EMA plotted on top to trigger buy/sell signals.

Relative Strength Index (RSI)

Traders use RSI to measure the intensity and rate at which prices change to determine overbought or oversold conditions. It helps determine potential trend reversal, validate the strength of a trend and identify entry/exit points.

Average Direction Index (ADX)

The average direction index (ADX) is used to measure the strength of a price trend. It helps traders confirm trends and identify weak/sideways markets by analysing the difference between positive Directional Index (+DI) and negative Directional Index (-DI) movements.

Bollinger Bands

Bollinger bands are a technical analysis tool that shows the volatility of a security and signals potential overbought and oversold conditions. If the security’s price is close to the upper Bollinger bands, then it might be overbought, and if it's near the lower Bollinger bands, then it might be oversold.

On-Balance-Volume

On-balance-volume is an indicator that uses trading volume flow to predict price movements. It helps identify potential price movements based on changes in trading volume, as price often follows the volume.

How to Get Started with Technical Analysis

To start using technical analysis, you need to learn to read price charts, understand key trading terms and how indicators work. Understand how to read different types of price charts, common chart patterns, types of trends, and practice identifying support and resistance levels for a security.

Since trading can be risky, it's recommended for beginners to practise trading by using a demo account to gain experience without losing money. To learn the basics of trading from industry experts, you can sign up for UpLearn by Upstox.

Who Should Use Technical Analysis?

Investors and traders can use technical analysis to identify entry and exit points for stocks, forex and commodity trading. Technical analysis is suitable for short-term investing and trading strategies since it focuses on short-term price movements and risk management, based on historical data and trends.

Technical Analysis vs Fundamental Analysis

Technical analysis uses price charts and volume to predict the future price movements of a security, while fundamental analysis helps determine the intrinsic value of a security. Here’s how both approaches are different.

Mistakes to Avoid When Using Technical Analysis

Over-reliance on Technical Analysis

One cannot solely rely on technical analysis for successful trading. Seasoned traders consider the market conditions and macroeconomic factors for smart trading decisions.

Overtrading

Don’t trade blindly. Wait for the right time and signal to enter a trade. You don’t always have to be in a trade. Enter a trade only if it seems favourable and backed by proper research.

Prediction Not A Guarantee

Technical analysis offers insights based on historical data and chart patterns, providing probabilities rather than guarantees regarding future price movement of a security.

Not Cutting Losses

Some traders are too stubborn and hold their positions even when the price is moving against them. In trading, not losing is more important than winning. Use a stop-loss to limit your risk exposure and cut losses.

Technical analysis is the study of the price charts and patterns to predict the future price movement of a security. Usually, short-term traders use technical analysis to earn profit by leveraging the volatility and short-term price movements of securities.

You can learn technical analysis from books, YouTube videos or from educational platforms like UpLearn and start trading in a demo account to sharpen your trading skills.