Investing in stocks can be a daunting task, especially for those new to the world of finance. It can be overwhelming to navigate the jargon and technical analysis that comes with investing in the stock market. However, with the right knowledge and guidance, anyone can become a successful investor.
One of the key tools used by investors to make informed decisions when buying or selling stocks is technical analysis. Technical analysis involves analyzing charts and statistical data to identify trends and patterns in the stock market. By using technical analysis, investors can make more informed decisions based on data rather than emotions or opinions.
In this article, we will take a closer look at the technical analysis of a stock and explore the basics of this powerful tool. We will discuss the different types of charts and indicators used in technical analysis, and how to interpret them to make informed decisions. Whether you are new to investing or looking to enhance your skills, this guide will provide you with a foundation of knowledge to help you navigate the stock market with confidence. So, let’s dive into the world of technical analysis and unlock the secrets to successful investing.
What is the technical analysis of a stock?
The world of stock market investing can be complex, and one of the most important tools that traders use is technical analysis. By examining historical data, technical analysis can help predict future price movements and provide valuable information to traders looking to make a profit.
At its core, technical analysis relies on interpreting the price action of a stock. Although it may seem like stock prices are constantly fluctuating, careful analysis over time can reveal patterns and trends that can be used to make informed investment decisions. Technical charts and trends are key components of this analysis, allowing traders to identify trends and make decisions based on patterns rather than speculation.
Assumptions for Technical Analysis of A StockÂ
To understand the technical analysis of stocks, you need to believe in three basic assumptions:
1. Market prices reflect stock information:Â It is essential to know about the stock prices while deciding whether to invest in it. The price information helps in assessing the current value or market value of a company.
2. Stock prices follow trends:Â Stock technical analysis is based on the assumption that stock charts have their own trends. Stock prices usually move within the trend. Every move indicates the next move in stock prices. You will be able to understand trends from the history of that stock.
3. Patterns are repetitive:Â This is a fact that a pattern repeats itself after a course of time. Suppose a pattern is like 1-2-3, then the pattern will restart from 1-2-3. Through such assumptions, you will be able to predict future stock prices.
Technical Indicators To Identify Market Trends
There are three types of technical indicators in the stock market: charts, moving averages, and momentum indicators. Let us learn about these stock technical indicators.
Charts
Technical charts are the graphical representation of stock price and volume. Through technical charts, traders can make decisions on financial investment in stocks. The main types of technical charts include:
1. Line Chart
It is one of the simplest technical charts that is used for analyzing financial markets. A line chart graphically represents the historical price action of an asset. It is also known as a close-only chart since it plots the underlying security’s closing price through a line that connects dots denoting the closing price.
In the line chart:
- On the x-axis (horizontal axis): time period
- On the y-axis (vertical axis): price levels i.e. the closing price of the underlying security
It is a very easy and understandable graph. Through line charts, one can learn to identify support and resistance levels, trend lines, and chart patterns. You will not be able to determine the price range for a session as well as the highs and lows.
2. Bar chart
These are one of the most used technical charts for plotting stock prices. This chart plots high, lows, open, and close prices for each time period. These can be used in the stock market technical analysis over the course of time. You can spot trends, monitor stock prices and make important trading decisions through these charts.
3. Candlestick Chart
Candlestick charts are one of the oldest technical charts that are used in the analysis of stocks. These charts offer a visual insight into market sentiments and the psychology of traders.
It represents the open and close prices, highs, and lows for the day. The rectangular bar is called the ‘real body’ which represents the price range between the open and close of the day trading. A down candle is colored ‘red’ and an up candle is colored ‘green’.
The two ‘lines’ that are extending from the real body are known as shadows or wicks. These wicks represent the low and high prices of the day’s trading. Candlestick charts are effective in highlighting the difference between opening and closing.
In candlesticks charts, many patterns are formed due to the up and down price movements. The two main patterns in candlestick charts are bullish and bearish. Bullish indicates the probability of a price rise and bearish patterns indicate a price fall.
4. Renko Chart
It is a technical chart built using price movement instead of price and standardized time intervals. Whenever a price moves a specified price amount, a new brick is created. Each of these bricks is positioned at a 45-degree angle prior to another brick. Traders can view asset price movements that filter out minor price movements through Renko charts.
Renko charts are easier to read as compared with candlestick charts since the markers are more uniform on Renko charts. Through Renko charts, traders can focus on important trends but due to the simple brick construction, you may lose out on some price information. Traders can effectively identify resistance levels and support.
5. Point and Figure (P&F) Chart
A point and figure chart helps in plotting price movements for bonds, commodities, futures, and stocks without considering time. Technical analysts use the concept of support and resistance in the case of P&F charts. These charts are less susceptible to false breakouts.
Moving Averages
It is one of the technical indicators that help in smoothening out the price data by creating a constantly updated average price.
Traders calculate the moving average to identify the trend direction of the stock. These also determine its support and resistance levels. This tool is based on past prices and hence it is a trend following/lagging indicator.
These are completely customizable technical indicators thus allowing investors to choose a time frame for calculating the average. A shorter time span will turn the average more sensitive to price changes. A longer time span will make the average less sensitive.
Those who want to opt for short-term trading can choose a shorter moving average. Those who want long-term investment can choose long-term moving averages. There are two types of moving averages: Simple and Exponential moving averages.
Momentum Indicators
Momentum indicators are the stock market technical analysis tools that determine the strength and weaknesses of the stock price. In simple terms, this technical indicator measures the rate at which stock price fluctuates. These technical indicators only hint at the time at which market price change is taking place.
Moving average convergence divergence (MACD) and relative strength index (RSI) are the two common momentum indicators.
MACD: This is a trend following the MOM indicator that indicates the relationship between two moving averages of a financial instrument’s price. It moves between moving averages. You can calculate it by subtracting the 26-day EMA from the 12-day EMA.
Then, you will plot the 9-day EMA (signal line) on a graph along with the MACD line. Traders get an indication of whether to buy or sell through MACD.
RSI:Â It is an oscillator that measures price change and the change rate. The indicators swing between 0 and 100. It helps in identifying uptrends and downtrends.
To calculate the value of MOM indicators, you can use the following formula:
MOM= (current closing price/closing price of the previous period) x 100
Importance of Stock Technical AnalysisÂ
Technical analysis of a stock is important for the following reasons:
- Stock technical analysts use the approach of probability to pick stocks. They can predict the outcome of any action without the need for in-depth scrutiny. These professionals will provide you with stock price movement details without much information.
- It takes less time than fundamental analysis. Those who want to earn returns in a shorter time period should opt for technical analysis of stocks.
- Through various technical charts and technical indicators, you can learn to understand the changes in patterns. Through the in-depth study, you will be able to detect changes in price movement. This will prevent you from facing huge losses.