Have you ever taken a look at a price chart of a certain stock and analysed the different price movements, such as price increases, reductions, or even price stagnation? If you have, then you have already started to familiarise yourself with the meaning of technical analysis.
In almost every stock or financial market, the most common method of analysing price patterns is referred to as technical analysis. Analysts of all levels, ranging from beginners to professionals, continue to utilise price charts, various market indicators, and a plethora of technical analysis tools daily.
In this article, we will analyse the meaning of technical analysis, explore the basic concepts of technical analysis, focus on some of the most widely recognised chart patterns, examine some of the most common technical indicators, and review some of the most popular technical analysis tools.
Technical Analysis Meaning
The study of the stock market as a result of the analysis of price charts, historical data, and trading volume is commonly referred to as technical analysis.
Instead of looking at a company's profits, balance sheet, or management quality, technical analysis concentrates on one core belief:
Price reflects everything
This means that a stock price reflects every piece of data that is accessible, including news, earnings, economic data, emotions, and expectations. Traders study how prices have acted in the past in order to find patterns and trends that may repeat.
In general, the technical analysis meaningreflects from the past to the future in order to find a target for the market.
Why Is Technical Analysis Important in Stock Market Basics?
In the beginning, stock market basics say that a lot of beginners should start with headlines and fundamentals. Although that is true, price movements and changes tell you a story.
Price analysis answers most of the time, fundamental questions:
When should I enter a trade?
Where should I exit to book profit?
When should I cut losses?
Is the trend strong or weak?
The primary difference between investing for the long run and trading is the time at which trading decisions must be made. This time element is why technical analysis is so important.
Core principles of Technical Analysis
To truly be able to tackle technical analysis basics you need to first understand the three fundamental principles you need to internalise.
1. Price Discounts Everything
People’s collective thoughts (including all the available data, market news, and expectations or reactions) are already incorporated into the price quotation of an asset. That’s why news are not really important for technical chartists. Just look at the chart!
2. Prices Move in Trends
Prices never move in a random fashion. They are bound to follow a certain direction (trend) - the price could go up, go down, or go sideways. Spotting the trend early is a key to winning side of the market.
3. History Tends to Repeat Itself
Over and over in market history, the same emotions (fear and greed) lead to similar outcomes. This is why certain chart patterns are able to be re-identified through time.
Types of Market Trends in Technical Analysis
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Trends are the foundation of understanding technical analysis.
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An uptrend occurs when the price increases to higher highs and higher lows.
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In contrast, a downtrend occurs when the price decreases to lower highs and lower lows.
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A sideways trend occurs when the price is range bound, moving narrowly.
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In trend trading, the trend almost always provides the more statistically significant trading opportunities.
Price Chart in Technical Analysis
The main foundation of technical analysis is the chart. Analysts cannot conduct a technical analysis without having a chart.
Line Charts
Line charts help to track how a security's price moves over time. This type of chart is helpful to identify price trends over time, but provides no detail on specific price points.
Bar Charts
Bar charts help to track price movement, but include more detail compared to a line chart. Bar charts include four prices: the open price, high price, low price, and the closing price. This detail helps investors understand a security's price movement throughout the day.
Candlestick Charts
Candlestick charts are the most popular type of chart among investors today. Candlestick charts are the most visually appealing and, more importantly, they convey more information compared to other types of charts.
Chart Patterns: Psychology Hidden in Price Movement
Every chart tells a story. More specifically, chart patterns convey the emotion and mindset of investors and traders. Buy and sell at what price, how many, and when are all determined by chart patterns.
Reversal Chart Patterns
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Reversal patterns mark the point of transition of the trend and signal a complete change.
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Some examples are head and shoulders, double top & bottom, and rounding bottom patterns.
Continuation Chart Patterns
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Continuation patterns show that the trend is taking a break, but the current trend line will continue.
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Some examples include flags, pennants, triangles and rectangles.
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Studying chart patterns helps traders respond and anticipate the market rather than rely on their emotions.
Support and Resistance: The Foundation of Technical Tools
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The most widely used tools of the trade are technical tools of support and resistance.
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Supportis a price level where buying interest is strong enough to stop prices from dropping.
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Resistance is a price level where selling pressure prevents prices from going any higher.
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These levels are ideal for entry, exit, or stop-loss placement.
Trading Indicators: Measuring Momentum
Indicatorsare simply a mathematical formula applied to price, volume, or a combination of both, which help traders validate trends, momentum and reversals.
Moving Averages
Moving averages help identify the direction of the trend by smoothing out the price data. The simple moving average (SMA) and the exponential moving average (EMA) are the two most common.
Relative Strength Index (RSI)
RSI indicates momentum as well as helping to identify when an asset is overbought or oversold and is one of the most commonly used indicators for reversals.
Moving Average Convergence Divergence (MACD)
Using two moving averages to identify momentum shifts, MACD is one of the most sought-after indicators to show changes in trend.
Volume Indicators
Correct price action is confirmed by volume. When the price is increasing and the volume is high, it shows that there is strong conviction in the price action, whereas low volume indicates hesitation.
Indicators, by themselves, should not be used to drive decisions, but rather to provide confirmationwhen other elements agree.
Most Popular Technical Tools of Traders
- In technical analysis, one particular tool is not the focus, but rather many, and it is the same for multiple indicators. Trendlines help to show where the price is heading.
- Fibonacci retracement levels assist in locating zones of potential support and potential resistance.
- Intra-day levels are calculated using pivot points.
- The market's momentum and fatigue are gauged using oscillators.
- The idea is to integrate various technical methods to enhance the chances of success, rather than trying to achieve flawless market predictions.
Technical Analysis vs Fundamental Analysis
Beginners frequently struggle with the differentiation of technical analysis versus fundamental analysis.
Fundamental analysis is the assessment of company performance, earnings, and valuation, plus the economic environment.
Technical analysis focuses on price patterns, trends, and the underlying psychology of the market.
Each of these theories is useful on their own; long-term investors value fundamentals, and technical analysis is critical for traders on the timing of their trades. Smart market participants often utilise a mixture of both.
Common Mistakes Beginners Make in Technical Analysis
- The technical tools are often misused by new traders.
- Too many indicators create confusion and don’t provide clarity.
- Poor trending direction leads to less prosperous trades.
- Unplanned overtrading leads to a slew of emotional decisions.
- Disappointment that indicators don’t pinpoint exact highs and lows is common.
The combination of technical analysis coupled with the discipline, patience and appropriate risk management tends to yield the best results.
Is Technical Analysis Reliable?
Winning at Technical Analysis is not a guarantee. However, having a more structured approach and rationale will enhance the quality of decisions made. Markets run on probabilities, and as such, there are no certainties. Traders use technical analysis to spot high-probability opportunities, help manage their risk, and maintain consistency.
When used correctly, technical analysis can become a powerful skill, and not just a shortcut to making easy money.
Who Should Use Technical Analysis?
Technical analysis is for:
- stock traders and investors,
- intraday and swing traders,
- commodity and forex traders,
- crypto traders,
- and anyone who wants to improve their timing in the markets.
Long-term investors can also use technical analysis to increase their control of entry and exit points.
Final Thoughts: Technical Analysis is a Long Road to Travel
Drawn lines and random indicators are not what technical analysis is about. It’s about how people are likely to respond to a price change. If you are just beginning in the stock market, then learning the basics of technical analysis first will make sure you have a more stable start.
DISCLAIMER: This blog is NOT any buy or sell recommendation. No investment or trading advice is given. The content is purely for educational and information purposes only. Always consult your eligible financial advisor for investment-related decisions.
