Technical analysis is one of the oldest market disciplines. It is widely used by traders for navigating through the markets. It is not a substitute to fundamental analysis but rather a supplement. Fundamental analysis tells you what to buy, but technical analysis helps answer the question; when to buy?
Technical analysis looks at actual trades in which market participants have a stake, and the bulls and bears have put their money where their collective mouths are. There is no revision of data or ambiguity, and there is no mystical divining of the future. All market and stock selection is based on current, not past, price performance.
The charts portray trends that form because information is slowly disseminated to the public in an imperfect manner, and as the public acts on the information, the market move. The trend continues to move until either the last group of people has acted or an outside influence, like news or some external event ends the trend. Just line in physics, a body in motions tends to remain in motion.
Human behavior is a key component of technical analysis. When similar market conditions occur, market participants tend to react in similar ways. This is how patterns and trends are created on a chart. At certain price points the bulls feel that a stock may be undervalued and buys it. When the price of the stock has risen enough either the bulls take profit or the bears come in and sell. These activities by the bulls and bears create support and resistance.
For example, the market holds fairly steady as buyers and sellers adjust their portfolio to meet their particular investment criteria. A stock might trade in a narrow range from 22 to 24 in this way. It does not necessary tell you if the stock is âgoodâ or not. All you know is that bulls and bears consider the stock fairly valued within this narrow range.
The chart shows the Market Vectors Etf (GDX) which has been trading in a narrow range between support and resistance of 36 and 42 respectively.
Now, letâs say that someone would come in and buy large block of stock, for whatever reason, more money flows into the market and increase demand for the stock, which rise in response to the higher demand. This is one of the oldest and most powerful rules in economics. If demand increases, the price must go up to induce sufficient supply (sellers) to come into the market and restore equilibrium. There must always be a seller for every buyer and the price determines where this transaction will take place. This process is actually fairly straight forward. It is the art of technical analysis to look at indicators such as chart patterns, volume, and momentum to see what the buyers and sellers are doing and which group is getting an upper hand.
That chart show the Market Vectors Etf (GDX) that is breaking out of its trading range in September. Notice how volume is increasing as the price keeps going higher.
When demand increase, market activity or volume picks up to provide supply. The chart also changes in character as people try to decipher what is happening. Fear and greed are the driving factors. Some market participants may think that the stock has changed and has become undervalued. It could be a new product launch, a new project, increased earnings, or foreign capital. Whatever it is some market participants know that something has changed, or think they know something about the new condition of the company. So at that point the market breaks out of its trading range, and as it does, momentum picks up as more market participants act.
As a stock market participant you need to be humble because the market is a lot bigger than you. You cannot tell the market what it should do, even if it is âwrongâ by all logical measures. The market can hold a losing position a lot longer than you or even your countryâs central bank can. What you want to do is to listen to the market. It will tell you where it is going, so you can jump on for a ride.
At worst you catch a false breakout, but with humility you can acknowledge your error and immediately cut your losses. At its best, technical analysis will never let you miss a big move. If the market is going to have sustained move, either up or down, technical analysis will help to keep you to stay in our out depending on your market strategy.
A good stock rise in price and make you money regardless of its name or ticker symbol. You should not only look for a flashy glamour stock or household names. These stocks may be good, but the focus should be on stocks where demand exceeds supply, and where the âsmart moneyâ has been since the early stage of the bull market. Stocks that are moving higher with increased public interest are good candidates. All this information can be found on the chart.
Looking at the following factors will increase your chance of finding a winner.
- An increasing price trend as more and more investors buy.
- Increasing volume as market participants becomes more aggressive in their buying.
- Strong, price momentum, but not excessive. Anything higher indicates that supply and demand are out of synch.
- A strong sector. Most companies in a strong sector will do well and it is likely to be enough business for all of them.
- A strong market. A rising tide raises most boats.
- Positive environment with low input prices, higher output prices, and favorable supply and demand dynamics.
All this information can be gathered from charts. Technical analysis provides a vast selection of tools for every type of analytical task. There are charts that display stock prices in time frames ranging from hourly, daily, monthly, and longer intervals. They show trends, bull and bear market cycles, and phases of fear and greed.
Technical analysis offers tools to interpret the market, which includes indicators to measure momentum, volume distribution, net open positions, and market breadth. Allow yourself to hear what the market is telling you and be able to listen to it, no matter what you may have thought beforehand. Watch patterns develop, take action, and realize your profit and success.