In this chapter we will discuss the basics of technical analysis every trader and stock market participant must know about. Technical Analysis is the art and science of forecasting future price on the basis of past price movements. Technical analysts focus on price movements rather than any fundamental information like financial performance, business growth etc.
Table of Contents
The basic psychology behind the Technical Analysis
Technical Analysts believe that, what the price showing is more important than why the price is moving up or down in order to forecast its future price movements. Common psychologies behind the technical analysis could be defined as –
Price discounts everything
Price represents the sentiments of all the market participants like big investors, small investors, traders, speculators etc. All the knowledge in the market reflects in the price. Hence they focus on analyzing the price movement of the instrument.
Price moves in a trend
On the basis of hundreds of years of historical price charts, Technical Analysts believe that price movements are not totally random, rather they moves in a trend. It is possible to identify the trend by analyzing the chart in various time frames and trade based on the trend. They believe “Trend is our Friend” and focus on “Trade with the Trend”.
History repeats itself
Decades of charts and patterns shows that price movements repeats itself in similar ways in similar types of situations because price moves as per the psychology of the market participants and human psychology and reactions in various circumstances remains almost same over the time. (That means the reaction of traders in various market fluctuations like the panic, fear and greed in them is almost same as it was in several years ago, the basic human psychology never changes.) Therefore Technical Analysts use various chart patterns to assume future price movements.
Demand & Supply
The base of Technical Analysis is demand and supply. As per technical analysis the price movement of shares depends upon its demand and supply. If demand for any instrument (like stock or commodity) is more than the supply then its price will increase and if supply is more than the demand then its price will decrease. And according to this each instrument (stock or commodity) has a demand (support) and supply (resistance) zone.
Tools & techniques for technical analysis
Technical Analysts analyze the price, volume, open interest etc. using charts, chart patterns, various indicators, oscillators etc. to forecast the future price movements as per their trading strategies.
Price action
Price action generally means analyzing the movement of price. In technical analysis price is the key factor. Everything is related to the movements of price and price defines everything like the market sentiments, news, fundamentals etc. price factor in everything. Different analysts use different methods and strategies to analyze the movements of price.
Support & Resistance
As per the demand & supply in the market the price shows some support & resistance zones. Support is that zone in which the demand increases and move up or may not go below that zone and resistance is that zone reaching which the supply increases and demand go down for which the price falls or may not go above for some time.
You can identify the support & resistance zones in the price charts either by manually drawing trend lines and channels or by using certain indicators like Moving Averages, Pivot Points etc.
Charts & Chart patterns
Charts are graphical representation of price movements. Rather than analyzing numbers in tables it is easy to understand it in pictures or in a graphical representation. Technical analysts analyze the price using various types of charts and chart patterns and indicators.
Indicators
Indicators are basically mathematical formulas applied to the price or volume and gives some indications about the price movement for better analysis. It helps in finding various support and resistance levels and give alerts and signals about breakout of levels.
We are using Zerodha web platform for all charts.
There are basically two types of indicators.
Leading Indicators
Leading Indicators generally shows the price momentum and gives early signal for entry and exit. Some commonly used Leading indicators are RSI, MFI, Stochastic etc.
Lagging Indicators
Lagging Indicators are generally trend following indicators. They follow the price and give a better picture of the price movements (whether it is falling or rising). They don’t give any signals to entry or exit rather they shows how the price is moving and help us to identify the trend. Moving Averages, Bollinger Bands, MACD are examples of commonly used lagging indicators.
Oscillators
Oscillators are basically types of momentum indicators which have an upper band and lower band (normally from 0 to 100) which indicates whether the price is overbought (in the upper side) or is oversold (in the lower side). It helps traders to make fresh positions (near over sold zone) and exit positions (near overbought zone) to book profits.
Relative Strength Index (RSI), Money Flow Index (MFI), Stochastic, Moving Average Convergence Divergence (MACD) etc. are some of the commonly used oscillators. You can add any indicator in your chart by searching it in the studies section and complete the setup or just use the default setup.
Conclusion
This is a short and basic overview of technical analysis just for information of beginners in stock market. You can read more about various concepts of technical analysis in our other chapters by clicking the link provided here or you can read various books and also check several articles available online. Thanks for visiting our page.
Disclaimer – Investing and trading in stock market is subject to market risk. We have to learn all the risk factors before making investment decisions. This article is only for basic knowledge about stock market investing for educational purposes only and not any type of recommendation. In case you need any professional advice please consult your financial advisor.
