Technical analysis is a method to find the trend of the market using price action movement. Technical analyst uses historical price-action charts and market statistics. By using technical analysis an analyst can find the historical price pattern of market. Using this historical price pattern, a good technical analyst could fairly predict future price trajectories.
Like weather forecasting, technical analysis does not guarantee absolute predictions about the future. Technical analysis can help investors to anticipate what is “likely” to happen to prices over time. It uses a wide variety of charts that show price over time.
Technical analysis is applicable to stocks, indices, commodities, futures or currency.
The time frame could be hourly, daily, weekly or monthly, Quarterly or yearly.
Technical Analysis Assumption
Technical analysis is applicable to securities where the price only influenced by the forces of supply and demand. TA does not work well when other forces can influence the price of the security. Three things every technical analyst must study
Liquidity – liquidity is also known as volume. High liquidity(volume) stocks allow investors to trade quickly and easily, without dramatically changing the price of the stock. Low liquid stocks are more difficult to trade because there aren’t many buyers or sellers at any given time. Low liquidity stocks often very low priced which means that their prices can be more easily manipulated by individual investors. These outside forces acting on low volume stocks make them unsuitable for technical analysis.
Markets discount everything – This assumption tells us that, all known and unknown information in the public domain is reflected in the latest stock price. An insider in the company may buy the company’s stock in large quantity in anticipation of a good quarterly earnings. The price reacts to his actions thus revealing to the technical analyst that this could be a good buy.
No Sudden News – Technical analysis cannot predict extreme or sudden events, including business events such as a company’s CEO dying unexpectedly, and political events such as a terrorist act. When force of extreme news are influencing the price, technical analyst have to wait patiently until the chart settles down.
No Artificial Price Changes – Splits, dividends, and distributions are the most common “culprits” for artificial price changes. Artificial price changes can dramatically affect the price chart and make technical analysis difficult to apply.
Price moves in trend – All major moves in the market is an outcome of a trend. The concept of trend is the foundation of technical analysis. For example, the recent upward movement in the NIFTY Index to 10000 from 12170 did not happen overnight. This move happened in a phased manner, in over 11 months. Once trend established then price moves in the direction of the trend.
History tends to repeat itself – “Trend is your friend”. The price trend tends to repeat itself.
Technical Analysis Basis:
According to Dow theory technical analysis is based three rules:
- Price discounts everything
- Price movements are not totally random (Price moves in trend)
- “What” is more important than “Why”
In his book, The Psychology of Technical Analysis, Tony Plummer paraphrases Oscar Wilde by stating, “A technical analyst knows the price of everything, but the value of nothing”. Technical analysts only concerned with two things:
What is the current price?
What is the history of the price movement?
The price is the end result of the battle between the forces of supply and demand for the company’s stock. The objective of analysis is to forecast the direction of the future price. By focusing on price and only price, technical analysis represents a direct approach. Fundamentalists are concerned with why the price is what it is. Technical Analyst believe it is best to concentrate on what and never mind why. Why did the price go up? There were simply more buyers (demand) than sellers (supply). After all, the value of any asset is only what someone is willing to pay for it. Who needs to know why?
The Indian stock market is open from 9:15 AM to 15:30 PM. During the 6 hour 15 minute market session, there are millions of trades that take place. Trade executes on the exchange every minute.
Market open at 9:15 AM and close at 15:30 PM during which there were many trades. It will be practically impossible to track all these different price points.
By tracking the Open, high, low and close we can draw a summary of the price action.
The open – After opening the market the first price at which a trade executes called the opening Price.
The high – This represents the highest price at which the market participants were willing to transact for the given day.
The Low – This represents the lowest level at which the market participants were willing to transact for the given day.
The close – The Close price is the final price at which the market closed for a particular period of time. The close serves as an indicator for the intraday strength. If closing price higher than opening price then market is bullish. But If closing price lower than opening price then market is bearish.
Points To Remember
- Technical analysis could be apply on stocks, commodity, currency, crypto currency.
- TA is based on few core assumptions.
- Markets discount everything
- “How” is more important than “why”
- Price moves in trends
- History always repeat itself