Hey there, friend! Today, I’m going to introduce you to one of the most popular analysis methods in the invesHello, my friend! Today I’m going to introduce you to one of the most famous methods of analysis in the investment world: technical analysis. Yeah, maybe you heard about it before, but what exactly is technical analysis? Some magic with charts and numbers, or it’s a decent strategy in some way? Don’t worry; I will answer all your questions. And I promise not in a boring way, but like you’re having a coffee chat with a buddy!
What Is Technical Analysis and Why Is It Used?
Technical analysis is a means of trying to project future price movements by analyzing market data of price charts and trading volume. In other words, we look at the asset’s past price movements-be it a stock, currency, or cryptocurrency-to try and work out what’s going to happen next. Now, for this, we have patterns, trends, formations, and many others on the charts. But don’t worry, I’ll make all that easy.
This is the method generally preferred by short-term traders. Yet, some of the tools of technical analysis may also be usable for a long-term investor. “So why are we using technical analysis?” you might ask. Simple to answer: in order to predict the future movement of the market and take wiser investment decisions! It is always safer to act with data in one’s hand instead of simply watching the market with a “quick glance”.
Fundamental Analysis vs. Technical Analysis: What’s the Difference?
By now, one may wonder, “Hey, there’s also this thing called fundamental analysis; is it the same as technical analysis?” Well, let me explain the difference right now. Fundamental analysis considers the financial situation of a company, income statements, balance sheets, and even the economic situation of the sector and country to draw conclusions about its future value. That is to say, it’s more about questions such as, “What is the actual value of this company-is it profitable?
On the other hand, technical analysis does not go that deep; only the price movement and volume of trade are its concern. It’s more like “How much has this stock risen, where did it get stuck before, how is the volume looking?” In other simpler words, it’s more about graphical and statistical data. Fundamental analysis answers “Will this company grow in the long term?” while technical analysis asks “What’s this stock going to do this week?
The Logic of Technical Analysis: Reasoning in Terms of Charts and Movements
There is no magic formula in technical analysis; it is wholly based on the belief that price movements can repeat regularly. People sell when they get scared and buy when they get greedy. So, price movements take shape according to this psychological cycle. Hence, analyzing the price movements and catching the trends may provide us with some opportunities.
Price Movements: The Trend is Your Friend!
Perhaps the most basic philosophy of technical analysis is this: “The trend is your friend.” If an asset is on an uptrend-that is, the trend is upward-investors generally follow the trend, and prices continue higher. Of course, the opposite holds true as well. That is, if a trend is downward, the selling pressure increases and prices continue to fall.
For the purpose of understanding trends, we have a few basic tools given below:
Uptrend: Prices are largely moving upwards.
Downtrend: Prices are largely moving downwards.
Sideways Trend – Consolidation: Price movement occurs within a narrow range. No particular direction is shown.
Support and Resistance: Points at which price is said to stop.
Another very important technical analysis concept is that of support and resistance levels. Although these terms sound pretty technical, they are pretty straightforward. If the price reaches a certain level in an asset where it seems to stop falling or rising, then that level may be regarded as a “support” or “resistance.”
Support Level: The price stops falling and buyers step in, saying, “It can’t go lower than this.” The price starts rising from here.
Resistance Level: Price is unable to go higher. The buyers are countered by the sellers, pushing the price downwards.
These levels are a result of the mass psychology of all the market players. Everybody decides to buy or sell at a certain level, which influences the movements in the price of the security.
Technical Analysis Tools: What Are the Tools of the Trade?
For performing technical analysis, we need some tools. These tools help us analyze price movements and try to predict what will happen next. Here are some of the most commonly used tools:
Moving Averages (MA): As the name suggests, a moving average computes the average price of an asset over a certain period of time, hence showing a flow or trend. It normally revolves around 50 days, 100 days, or 200 days.
For example, if an asset is trading above its 50-day moving average, then that could be a very good omen; after all, such a scenario would imply that it is above the average of the last 50 days. Of course, if it falls below the moving average, then that could be a sign of weakness.
RSI: This is an indication of whether the price currently is in the overbought or oversold zone. Actually, it ranges between 0 and 100, but normally, whenever it goes above 70, people say, “This asset is overbought; it may fall soon.” Whenever it’s below 30, they say, “Be careful, this is an oversold situation; it may bounce back soon.
MACD: This sounds complicated, but actually, MACD is quite simple. MACD plots two Exponential Moving Averages on the same chart as the difference between them. When the short-term average crosses above the long-term average, this could be taken as a buy signal. If the short-term average crosses below the long-term average, it may be a sell signal.
Bollinger Bands refer to the volatility of the movement of prices. If the bands widen, the market is volatile; if they narrow, it is a quiet period. If the price breaks above or below the bands, this can be viewed as an indication that the price has moved into overbought or oversold territory.
Investment Strategies in Relation to It: Just Charts or a Strategic Move?
You might ask now, “Okay, we have seen the charts, but now what do we do with this info?” And that’s where investment strategies come into play. Technical analysis can be used to inform investment strategies, and in some cases, it can even be the backbone of those strategies.
Swing Trading: It is a form of trading in which the technical analysis enters to attempt to catch short-term market swings. The trading objective is accomplished here through using the formation of support and resistance levels. In other words, buying around the immediate support levels of an asset, selling it at its resistance level would certainly lead to smaller earnings that are considerably realizable with consistency.
Trend Following: If some asset is in an uptrend, it may be sound to follow the course of that trend. It could be named as a trend-following strategy wherein you try to identify a trend with the help of technical analysis tools and take buying or selling decisions based on that. You close your position whenever you see it start to reverse.
Day Trading: This strategy is entirely based on the temporary movement of prices. You start your day with analysis, try to catch the fluctuation in prices, and close the position by the end of the day. In this case, volatile assets are preferred, as in case of small movement of prices, you will not earn much profit.
Conclusion: What does Technical Analysis offer to Investors?
These different concepts of technical analysis allow investors to perceive and predict price movements. Yet, one must be aware that, by itself, it cannot guarantee certain results. Markets are always full of surprises, and that is why technical analysis should be done in tandem with other techniques. By the end of this primer, price charts might begin to look like works of art to you, but the main ingredient is patience and discipline.
In other words, with technical analysis, you will get a better feel of the market and hence a better way in which to set your investment course. Just remember: analyze, follow trends, but always be prepared for the odd surprise the market can spring on you! I really hope you have fun and find this guide informative. Now get your coffee ready and review those price charts!