So what is technical analysis? Technical analysis is like looking at a financial history book. It checks out past prices and how many stocks were bought and sold.
Traders who use technical analysis try to guess what might happen in the future based on what happened before. They look at how people act in the market and use math to help them.
There are two main parts to technical analysis: chart patterns and special indicators that help with guessing.
| What is technical analysis: Highlights |
|---|
| Traders use technical analysis to determine when to buy or sell stocks in order to make a profit. |
| Investors examine price charts to identify the optimal times to enter or exit a trade. |
| A key concept in technical analysis is that a stock’s price already includes all available information. Therefore, interpreting price charts correctly can lead to sound decision-making. |
What you'll learn:
➤ What Is Technical Analysis?
Technical analysis is like reading the language of stock prices. It’s all about figuring out if the way a stock’s price is moving right now will keep going or change direction. Imagine it as a detective work with different tools like trendlines, candlestick shapes, and mathematical patterns.
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Why Traders Use Technical Analysis
People who use technical analysis have their favorite tools. Some like trendlines, others prefer candlestick shapes, and some use mathematical patterns like bands and boxes. But most use a mix of these tools to spot when it’s a good time to start or stop a trade.
For example, they might see a special shape on a chart that tells them it’s time to sell a stock short. But before making a move, they’ll check moving averages for different time periods to be sure it’s the right decision.
Technical Analysis history
Believe it or not, people have been using technical analysis for centuries. In the 17th century, a guy named Joseph de la Vega used it to guess what might happen in Dutch markets. But it really took off in a modern way thanks to folks like Charles Dow, William P. Hamilton, Robert Rhea, Edson Gould, and even a ballroom dancer named Nicolas Darvas.
They saw the stock market like a rising and falling tide, something you could track on a chart instead of digging into a company’s details. In 1948, the ideas from these early experts came together in a book called “Technical Analysis of Stock Trends” by Robert D. Edwards and John Magee.
Candlesticks in Technical Analysis
Candlestick patterns go way back to Japanese merchants who wanted to spot patterns in their rice trading. Fast forward to the 1990s in the U.S., when the internet made day trading popular. Investors started studying old stock charts to find new patterns for making trades.
Candlestick reversal patterns became especially important. They help investors predict when a stock might start going down. There are a bunch of these patterns, like the doji and engulfing pattern, that investors use to spot a bearish reversal, meaning a drop in stock prices.
➤ How to Use Technical Analysis (in 4 Easy Steps)
1. The Big Idea: Technical analysis starts with a big idea – the stock’s price already knows everything. That means you don’t need to worry about economic news or fancy stuff. It’s all in the price.
2. Follow the Trends: People who use technical analysis think prices move in patterns. And guess what? These patterns often happen again and again because people act similarly in the market. This is like history repeating itself.
3. Two Types of Analysis: There are two main ways to do technical analysis:
- Chart Patterns: Imagine you have a secret code in the stock chart. Experts look at patterns on the chart to find the code. They believe these patterns can predict where prices will go. For example, they might spot a triangle on the chart and say, “Hey, this means the price is going up soon!”
- Technical Indicators: This is like using math to read the stock’s mood. Experts use fancy math formulas on prices and how many stocks are traded. The most common one is the moving average, which smooths out the price to make trends clearer. There are also more complex indicators like MACD that look at different moving averages.
4. Making it Practical: Many trading strategies are built on these indicators because they’re based on numbers and math. So, you can use these tools to help decide when to buy or sell stocks.
In a nutshell, technical analysis is like decoding the stock market’s secrets by watching how prices move and doing some math to make smarter choices.
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➤ Fundamental Analysis vs Technical Analysis
In the world of finance, there are two major camps: technical analysis and fundamental analysis. Let’s break down the key differences between these two approaches in a straightforward way.
Fundamental Analysis: This approach believes that the market sometimes doesn’t give things their fair value. Instead of looking at price charts, fundamental analysts dig deep into a company’s financial health.
They examine things like the company’s money situation, its business, and how the market sees it. They’re like detectives searching for the real value behind a stock, even if the price doesn’t show it.
Technical Analysis: Technical analysts are all about watching how the market behaves right now. They say you can find clues in the way prices move. They follow trends, like looking at waves in the ocean. They don’t care much about a company’s details. They’re more interested in patterns on charts and doing math on stock prices and volumes.
The Speed Factor: Here’s the kicker—technical analysis is like a speedy race car. It helps traders make quick decisions because it’s based on what’s happening right this moment. Fundamental analysis, on the other hand, is like a slow-moving freight train. It takes more time because you’re digging into a company’s history and details.
Technical Analysis Limitations: Technical analysis has some downsides too. Sometimes, people read charts wrong or use the wrong math. And here’s a unique thing about it: when lots of people start using the same technical tricks, it can actually change how prices move.
For instance, if everyone starts believing that three black crows mean the price will drop, they might start selling, and that belief can make the price drop even if it wasn’t going to naturally.
In a nutshell, fundamental analysis is like peeling back the layers of a company to find its true worth, while technical analysis is all about reading the current signs in the market to make quick decisions. Both have their strengths and weaknesses, and some traders even mix a bit of both to find their winning strategy.
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➤ Final thoughts
In the world of finance, understanding technical and fundamental analysis is vital. Choose your approach wisely—swift trading with technical analysis or in-depth research with fundamental analysis. Success often lies in blending both methods to suit your goals and risk tolerance.
Remember, knowledge is your strongest asset. Stay informed and adapt your strategies as the market evolves. Your financial journey begins with a well-informed approach—whether technical, fundamental, or a mix of both.
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