Technical analysis is a technique used by investors in the share market to forecast the future price of shares by analysing previous trading movements. This trading technique has been used for decades by many investors to predict industry trends and estimate the value of shares. The main principle of technical analysis is that the share market price itself indicates all available data that could impact that market. Meaning, there’s no requirement to study fundamental, economic, or recent developments as they’re already priced according to their market value.
Technical analysts are of the view that prices shift in trends and past trends tend to repeat when it comes to the overall share market psychology. As a result, they evaluate the statistical numbers and chart patterns of shares and trends in order to discover how the stock price may evolve in the future.
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Types of Technical Analysis
The two main types of technical analysis are statistical indicators and chart patterns.
1. Statistical Indicators
Statistical indicators, also commonly known as technical indicators are a method of technical analysis where investors implement different analytical and mathematical formulas to volumes and prices. The most basic statistical indicators are moving averages that help smooth out price movement by filtering random price variations and makes it easier to detect trends. Complex statistical indicators include the moving average convergence-divergence (MACD), which studies the interaction between various moving averages. Many investing practices are dependent on statistical indicators as they can be quantitatively measured.
2. Chart Patterns
Chart patterns are a subjective application of technical analysis wherein investors try to recognise areas of resistance and support on a chart by studying selective price and trend patterns. Certain patterns are devised to foretell where the price of a share is directed, following a breakdown or breakout from a particular price point and time. There are generally four types of chart patterns used by technical analysts namely; line chart, bar chart, candlestick charts, and point and figure charts.
Importance Of Technical Analysis
Joseph de la Vega initially adopted technical analysis techniques in Europe to foretell the Dutch markets in the 17th century. Similarly, in Asia, Homma Munehisa encouraged the invention of candlestick charts to recognise chart patterns. Thus, technical analysis has played a pivotal role in the share market for numerous decades and it is important for every investor to learn its impact in investing.
Let’s have a look at some of the reasons why technical analysis is valuable to the share market.
1. Identify Support and Resistance Levels
By implementing technical analysis, traders can ascertain support and resistance levels of the price of a security at which it will most likely stop and reverse. These levels represent the price levels on charts that sometimes behave as barriers, limiting the price of a security from shifting in a particular direction. Once you are capable of identifying support and resistance levels, you tend to make informed decisions when it comes to investing in a particular share. When the prices of shares surpass the barrier, it indicates that the supply and demand chain is in an excellent state.
2. Mathematical Approach:
Technical analysts make use of probability to select certain shares that they want to study. By utilising probability, the investor is able to predict the result of an action without necessarily having to examine it in depth. Thus, the technical analysis of shares indicates how the prices will move without expecting you to worry about the minute details making it much faster and less challenging than fundamental analysis.
3. Recognition Of Short-term Trends:
When it comes to fundamental analysis, it is suitable for traders and investors who wish to invest for longer periods such as 5 – 10 years or more. It takes time for any business model to become profitable. Thus, investors have to stay prepared and remain patient. However, this is not the case with technical analysis. It can reveal whether the share is going to go up or down in the near future making it a great tool to identify short-term trends and investment strategies to gain high returns.
4. Indicator Of Expected Risk:
Fundamental analysis cannot predict any future decline in share prices that is about to occur. However, by studying historical chart patterns and other technical tools such as candlesticks, triangles, rectangles, the MACD histogram, Bollinger bands, an investor can predict the drop in share prices. Technical analysis may not determine the reason behind the fall, but it can most definitely forecast it. For instance, before the global financial crisis of 2007 – 2008, everything in the share market was going as scheduled, and nobody could predict the downfall of the share market. Though, technical analysts had already predicted that markets were about to enter one of the greatest crisis ever.
As an investor, it is critical to exercise caution while implementing the principles of technical analysis for investment choices. This is particularly true for beginners in the share market. Understand all the essentials and analyse the various technical analysis tools carefully to help determine the ones that fit you and your investment strategy.
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