Technical Analysis Of Stocks
Seasoned
investors optimize their investment decisions based on varied approaches. One
such universally acclaimed approach is technical analysis.
It is
widely used by investors to identify short-term and long-term trends and to
know when to time their action. It further helps to identify support and
resistance levels to help make sound investment decisions.
The
approach is focused on ascertaining whether or not a current trend will
continue and, if not, when it will reverse.
Technical
analysis focuses only on the price of the shares and not on the operations of
the company. It considers that the current or past price action in the market
is the most reliable indicator of future price action.
Let us
get a deeper understanding of what is technical analysis and what are the tools of technical analysis.
What is Technical
Analysis?
Technical
analysis is the interpretation of the price action of a company’s underlying
stock.
Sounds
complicated? Let us simplify this for you.
Technical
analysis is a method used by traders and investors to forecast future price
movements of stocks by analysing past trading activity. It utilises
various chart patterns and
statistical indicators to identify price
support and resistance levels, range and trends.
Understand
it this way.
The
price of a share moves up and down on a regular basis. But, if you look at the stock price movement over time, you may notice some trends and patterns emerging.
Technical analysis is nothing but the study of these chart patterns and trends
in stock prices.
It is
the study of historical market data, including price and volume. Some of the
important factors that help technical analysts in predicting future market
behaviour are market psychology, quantitative analysis and behavioural
economics.
Tools of Technical Analysis
Technical
analysts make use of a combination of tools and indicators to identify
potential entry and exit points for trades. These tools and technical indicators are
as follows:
· Charts
Charts
act as the canvas where the story of a stock is painted. The common types of
charts are candlestick, bar and line charts.
Price
and volume charts are the most widely used technical analysis tools. A
price chart depicts the sequence of prices plotted over a specific timeframe. A
volume chart depicts the number of shares of a company traded in the market over
a specific timeframe.
Charts
are generally used along with trendlines.
· Momentum
Indicators
Momentum indicators measure the momentum of a stock including
overbought and oversold conditions. They are statistical figures that are
calculated based on the price and volume data of stock. They help to
generate effective entry and exit signals for the traders.
While
most of the technical indicators majorly focus on determining likely market
direction (up or down), momentum indicators primarily focus on determining
market strength. This helps traders determine whether the current
price movement represents range-bound trading or an actual significant trend.
Some
of the widely used momentum indicators are Stochastic Oscillator, Relative
Strength Index (RSI), Commodity Channel Index (CCI), Average Directional
Movement Index (ADX) and Moving Average Convergence-Divergence (MACD)
indicator.
Momentum indicators act as supporting tools for
charts and moving averages.
· Moving
Averages
Moving
averages are used to remove sharp and frequent fluctuations in a stock chart. Sharp
movement in stock prices within a short period of time can often make it
challenging to predict the trend in the stock chart. Moving averages help
eliminate this impact and make a trend more prominent.
Some
of the commonly used moving average tools are Exponential Moving Average (EMA),
Linear Weighted Average (LWA) and Simple Moving Average (SMA).
Conclusion
As an
investor, you may want to apply the principles of technical analysis to your investment decisions.
It will help you make informed investment decisions by ascertaining the potential
risk-reward ratio.
Open a
demat account with Indira Securities and start your investment journey right
away!