Understanding the Benefits of Technical Analysis

Making investment decisions relies on utilizing two main methods of analyzing stock picks. These two methods are fundamental analysis and technical analysis. The two are very important when analyzing stocks, but are very different in their approaches. Fundamental analysis looks at the company in detail from the management to the industry sector. Technical analysis has no interest in the value of the company and only focuses on the price movement in the stock market. It looks at the supply and demand in a market to determine direction or trends in the future.

Technical analysts will look at data, mainly on past volumes and prices; they use stock charts and other tools to identify patterns that could indicate future performance. Technical analysis is based on three assumptions, the first being market action discounts everything. This means that at any given time, anything that can or could affect a company will be reflected in the stock price, including fundamental factors. This means that technical analysts see no reason to consider these factors separately. Secondly, price moves in trends, meaning that after a trend is in effect, the future price movement will be in the same direction as the trend and not go against it. A technical analyst may give you stock tips based off this fact.

Thirdly, history tends to repeat itself, mainly through price movement. The repetitive nature of price movements is as a result of market psychology, because investors in the stock market today consistently react to similar situations over a period of time. Technical analysis uses charts that sometimes are hundreds of years old because it is believed that the historical data will show repetitive patterns in price movement. Many traders will use technical analysis not just for stock picking or trading stocks, but also for futures, commodities, or currencies. This is because technical analysis can be used on any securities with past trading data.

Trends are an important factor in technical analysis, and there are three types of trends; upward trends, downward trends, and sideways or flat trends. When you observe a chart and see a series of peaks and troughs with each successive one higher than the other, this indicates an upward trend. Conversely, if you see the peaks and troughs successively lower than the previous, it indicates a downward trend. Little or no movement up or down would be a sideways trend. Trend patterns on a chart are important as it allows you to identify support and resistance points. These are areas where trends cannot move higher or lower and are normally followed by a reversal.