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Technical Analysis Definition
Technical analysis is a study of historical price and volume of the stock to predict its future behavior. Technical analyst study these price movement and identify formation of patterns that are formed repeatedly and the behavior of price after formation of patterns. If probability of price movement after these pattern, in certain direction, is very high then, analyst can bet on the buying or selling of the stock.
Basic principles of Technical analysis Technical Analysis is based on these three principles:
1. Price Discounts Everything: Technical analyst believe in efficient-market hypothesis (EMH). This means the current value of the stock, is fair value of the stock and has correctly factored in all the information that could affect the price of the stock at any given point of time.
2. Price Moves in Trends: Technical analyst believes that share price moves in trends whether upward or downward or sideways. And they will continue to do so in future. They go by this assumption to trade in stocks.
3. History Repeats Itself: Technical analyst believe that market movement in a certain situation would be similar to its movement in the past. Or Investors in certain scenario, even though they are irrational, will behave in similar way as they behaved in past. These typical movements are studied by analyst and are used to take advantage in trading stocks for a given situation.
On Analyzing stock movement in greater details, technical analysis helps to find two things.
1. Demand & supply: If technical indicators suggest that there could be surge in demand then price may shoot up and vice versa. Some indicators like
gauge over bought and oversold conditions. If indicators suggest sustained demand/supply, then stock moves in trends
. Some indicators like MACD & Moving Average helps to find beginning of trend or end or reversal, while some like ADX tells about trend strength, while some tries to find where and how money is flowing.
2. Possible behavior of traders/investors in certain situation: Price movement of shares tend to follow certain trends, this is a result of traders tendency to react in certain way after some news. These behaviors results in typical chart pattern. Chartist carefully observes price and volume to see strength or weakness of the trends and try to take advantage of emotional decision taken by the parties. Similar market cycle, accumulation/distribution and chart patterns like triple top, resistance line are observed again and again.
Minimum Period for Technical analysis
In contrast to fundamental analysis, technical analysis can be applied at any period of time from few minutes to many years. Owing to shorter time interval, they have become extremely popular with day traders and swing traders who trade may trade several times a day or may trade in duration of few trading days to few weeks to few month.