What is Technical Analysis?
Technical Analysis
Introduction
Trading involves entering high probability trades consistently and riding the winning trades, while quickly cutting losing trades. To achieve this one needs a rigid analysis technique that enables you to carefully manage risk and promptly make decisions when needed. There are 2 schools of thought on analysis of markets – Fundamental Analysis and Technical Analysis (TA).
Technical Analysis vs. Fundamental Analysis
There is an ongoing debate about the better method of market analysis.
Fundamental analysis (FA) is the method of evaluating the worth of a security by studying the financials of the security, that is: Income, expenses, assets, liabilities, management, industry, market share and basic supply and demand principles. In other words FA uses the fundamentals of the business. Fundamental analysts try to evaluate the true value of the company and therefore buy and sell based on the ‘value’ of the business. There are many people that have done very well out of FA, for example Warren Buffett, the richest man in the world, is a student of FA. Warren Buffett is an impeccable judge, and his ability to judge the ‘value’ of a company is widely publicised. But he is a rare breed of analyst and definitely not typical.
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There are many downfalls of FA -
- A company’s profit and loss is constantly changing.
- Forecast earning from analysts are constantly changing.
- The markets valuations on industries are constantly changing.
- Market conditions in industries can rapidly change
- The fundamental analyst’s thoughts and beliefs strongly influence their interpretation of the ‘value’ of the company.
With all these factors constantly changing, how can one know at any one time what a company’s true value is? Entering and exiting positions on FA alone is fraught with danger and generally throws risk management out the window, replacing it with hope that your own judgments are right and the market agrees with those judgments. I strongly believe that all fundamental analysts should AT LEAST have a basic understanding of technical analysis. It is a powerful tool in identifying market trends and exactly what the market is doing.
Technical analysis (TA) or charting is the process of studying price movements from the past and using that information to predict movements in the future. The reason it is so effective is that it shows what the masses are doing; it’s a gauge of mass psychology. The chart shows where the masses are buying, where they are selling, and what the trend is, among other things. There is no way of passing your own opinions and judgments on it. The chart shows exactly what is going on in the market; the trick then, is learning how to read it.
Technical Analysis is a cross between an art and a science. It is based on 3 basic beliefs:-
- Price movements are much more significant then fundamentals.
- Price tends to move in trends
- Price tends to repeat patterns.
Your analysis will provide you with the tools to increase the probability of profitable trades dramatically. There is never a 100% method or signal, but by combining high probability trading opportunities with good sound money management over the medium term to long term you will come out highly profitable.
Excerpt from ‘The Everyday Trader’s Stock Market Education Course’
