Analyzing financial markets is important to any investor. The technique used to analyse will be determined by multiple factors, such as whether the investment is long term or short term and also the kind of trading the investor wants to get into.
Technical analysis is a form of prediction of changes in stock prices based on analysing data collected from the past. It does not analyse the financial performance of a business or company but rather, it focuses on the price and volume to identify opportunities to trade.
Technical analysis is commonly used by traders and people who are investing short term. It uses past data in the form of charts to predict future prices of shares.
Assumptions Of Technical Analysis
Market
The assumption is that the price is depicted in the stocks. This is why it does not analyze the financial statements of companies. The analysis, therefore, focuses on price movements within the market. This is also based on the belief that the price will shift based on demand and supply patterns for any stock in particular, within the market.
Price Trends
The second main assumption is that there are always trends to be observed regardless of the time frame that has passed. This means that there are fewer coincidences or errors to be observed than actual patterns and this is the basis of the analysis. This particular means of analysis is common in trading strategies.
History
The third assumption is that trends and patterns tend recurring and this forming a pattern known as market psychology. Patterns in things like price movements are commonly characterized by predictable traits in the market such as fear or excitement. Analysis of charts can depict these trends.
Tools For Technical Analysis
Prices
There will be a change in the prices of securities as the market changes. The factors that influence the changes are the attitudes of the investors whose decision is also influenced by the demand and supply within the market.
Time
Time influences time in that, the more time passes, the more prone the market is to a reversal in trends. The price movement is therefore determined by the passage of time.
Volume
The higher the transaction volume in the market, the more prices are affected. So in cases where the prices change but the market volume is unaffected, it means that the change was not great enough to influence the market.
Width
Only when a change in trend is widely spread will a price change be considered as a quality change. The changes seen in prices of securities should be have taken place within the market forming an overall trend.
Advantages of Technical Analysis
- Quick Analysis
Since technical analysis uses charts and does not require looking at financial statements of companies, the research isn’t as long and tedious. There are also automated mechanisms of analysing trends which cut on time spent analyzing.
- Creating Strategies
A common use for technical analysis is in the creation of investment strategies. They help define risk clearly for potential investors but also create good reward profiles.
- Fundamental Analysis Assistant
When making a fundamental analysis, some factors and patterns may not be picked up. Technical analysis can help improve time and give a clear analysis of market psychology making longer-term investments worthwhile.
Disadvantages Of Technical Analysis
- Subjective
Technical analysis is considered to be an art rather than a strategic formula to be followed. It cannot be proved to leave much to be desired. Investors have to rely heavily on their judgement which is subjective and this makes any kind of decision or investment volatile.
- Ambiguous
Because the analysis is subjective, results on similar data can be very different leading to ambiguity. Data can be interpreted ambiguously such that forming a singular opinion or view proves to be a challenge.
- Low Win
To get a tangible, value on your investments, an investor must make multiple trades. Their volatility and unpredictability make it’s difficult to score a profit.
Wrapping It Up
Technical analysis is mainly for short term investments and is common among day traders. It is great for determining market entry and exit points and can therefore be beneficial for longer-term investments as well. Investors mainly use this form of analysis when they want to buy stock from traders that expect to sell at a higher price.
