Indian markets have always been volatile. Every investor, thus, wants to adopt the best method available to analyze the performance of stocks. One such method that is widely used by the investor is Technical Analysis. Technical Analysis is used by the investors to capture the ups and downs in the market, which are likely to come in one or two weeks.
What is Technical Analysis?
Technical Analysis is a method of stock analysis where the historical chart patterns of the stocks that are available publicly are analyzed. Technical Analysis, as a method of stock analysis, is used primarily associated with equities. However, it can also be used for analyzing different types of investment securities.
In simple words, technical analysis refers to predicting the behavior of the stock price by looking at the previous trends of prices and volumes. Technical Analysis is conducted with the help of charts and technical indicators.
Technical analysis is used by and is suitable for short-term traders or day traders who invest in the stock market intending to make quick money. They do so by observing patterns in the stock prices.
These short-term traders are not concerned about the overall health of the company and hence are least interested in knowing the fundamentals of the company before investing.
Assumptions of Technical Analysis
Technical analysis is usually applicable only to the securities, the prices of which are influenced by the demand and supply forces. Hence, technical analysis does not work well when the other forces can influence the prices of the securities. Thus, there are certain assumptions which are put in place before conducting technical analysis for a stock. It is also essential to make these assumptions because if not, they might lead to loss-making trades.
Such assumptions related to technical analysis are as follows:
- Stock prices are a reflection of the known and unknown information on the public domain: It is assumed that all the factors that can have an impact on the stock prices have already been taken into consideration and discounted from the current stock price. Thus, the price is currently trading at a fair value. It is assumed that the stock is neither underpriced nor overpriced.
- Predicting Price Movements: This assumption means that the price movements of the stocks can be predicted. Though the stock market projects some random trends, it is still full of identifiable trends. Once these trends are spotted, they can make huge gains for the traders. This assumption also states that once the trader understands the stock market movements through technical analysis, he can easily strategize by buying stocks at a low price and selling them when the prices of the stocks shoot up.
- Considering history: This assumption of technical analysis states that people react to the price movements in almost similar ways from time to time. This happens because stock market trends usually repeat themselves. For instance, when there is a bearish trend in the market, the traders tend to sell their stocks due to negative sentiments regarding the market even though the prices of the stocks are quite low.
- Focusing on short-term period: As mentioned above, technical analysis is conducted for short-term. The focus of technical analysis is on the short time duration that might range from one month to just a few minutes. Technical analysis, therefore, focuses on quick buying and quick selling, focusing majorly on short-term investments.
Importance of Technical Analysis
Technical analysis is continuously gaining popularity all across the globe. This might make you wonder why it is so popular. Here are some reasons why technical analysis is important and hence is gaining traction:
- It adopts a mathematical approach: Technical analysis is a mathematical approach that picks up stocks based on probability. Picking up stocks based on probability helps analysts to pick up stocks by predicting the outcome of an action rather than by scrutinizing the information in great detail. This also justifies the fact that technical analysis is simply concerned about the price movements of a stock and does not get into the detailed study about the company or what caused the changes in the prices of the stocks.
- It gives signs of danger beforehand: Markets happen to be volatile all the time. Many a time fundamental analysis fails to predict a major fall in the stock price, which is about to happen soon. However, with the help of historical charts and technical indicators, it becomes easier for the technical analysts to predict the fall. Technical analysis might fail to tell you the reason behind the steep fall, but it can surely inform us that the fall is about to come. This helps traders to prepare themselves accordingly for the fall.
- Identifying short-term trends: Fundamental analysis is suitable for traders how are looking forward to long-term investments say for a duration of three to five years. This is majorly because profitable business models have a gestation period and take time to be successful. Thus, technical analysis is not suitable for long-term investments.
Technical analysis cannot predict a company’s profitability. It only given and information regarding the upward or downward movement of the stock price in the near future. Hence, it is suitable only for short-term trades that involve quick buying and selling of securities.
Importance of Stock Charts in Technical Analysis
Technical analysis is done by analyzing different technical indicators and charts. Stock charts act as a canvas where the story of a stock’s movement is painted. Some of the most common charts used for technical analysis include line charts, bar charts, and candlestick charts. However, there are various other charts that are used by analysts at their discretion. Charts plot the prices where trades have already been executed. The time interval of these charts is set using settings. These time intervals segment the price action of the stock. These charts thus help the traders in seeing the past trend of price movements and the likely trend for the upcoming future and hence make a profitable decision of either buying or selling the stock under review.
Technical analysis is as important as fundamental analysis, just that the fundamental analysis is done for long-term investments, while technical analysis is done for short-term investments. It helps in taking quick buying and selling decisions to take advantage of the price movements and earn profits.