If you are new to trading, then the term technical analysis is something that might have glanced your ears quite often. But what exactly is it and why should you be more interested? Technical analysis is a way that a trader gets to know how a market might behave in the future by studying its past performance data and more especially the price and volume. Let’s begin by understanding some of the core aspects of technical analysis in simplistic terms as we progress through this guide.
What is technical Analysis?
Technical analysis is like the weather forecast for the stock market. Just as meteorologists use patterns in the weather to predict rain or sunshine, traders use price patterns to predict whether a stock will go up or down. The key idea here is that history tends to repeat itself, so if you can spot a pattern, you might just have an edge in the market.
Why is Technical Analysis Important?
For newcomers to technical analysis, it is especially important to realize that the more informed you are the better. Instead of making day trading decision based on emotions you can do it based on the patterns that have worked time and again. It’s a way to cut through the noise and focus on what really matters is the price action.
Basic Concepts in Technical Analysis
- Price Trends
Trend is the overall direction of movement in a market or a particular stock. There are three types of trends: In this context, we have the bullish, which is an upward movement, the bearish, which is a downward movement and the sideways movement. The analysis of trends is the initial step in technical analysis since it will assist you in executing a trade in conjunction with the market trends.
- Support and Resistance
Supply is a price level that attracts demand to resist a stock from going lower. In contrast, resistance is a price level where the downward pressure does not allow the stock to go higher. Support can be thought of as the bottom and resistance as the top. Knowledge of these levels assist in making good trading decisions.
- Moving Averages
A moving average is used to filter price data to find a trend over a certain period of time. The two basic categories of using moving averages are simple moving averages (SMA), and exponential moving averages (EMA). Another use of moving averages is to determine when a new buy or sell signal has opened up.
- Volume
Volume is the total number of shares that are traded within a particular period of time. It is a measure commonly used to monitor and gauge the activity and resiliency of a particular market. High volume generally overpowers the market with conviction of the price direction while low volume is generally accompanied by a lack of interest in the move or uncertainty.
- Candlestick Patterns
Candlestick charts are one of the most frequently used forms of technical analysis of price. Each bar or ‘candlestick’ corresponds to one time period of trading, commonly one day and is illustrated by the opening price, highest price recorded, the lowest price recorded and the closing price. These candlesticks help create patterns that show possible market reversal or continuation.
- Relative Strength Index (RSI)
RSI is an oscillating indicator that shows the extent and velocity of new trends. It stands between 0 and 100 and is interpreted as overbought above 70 and oversold below 30. Looking at the relative strength index, it is possible to determine early reversal points.
- MACD (Moving Average Convergence Divergence)
MACD is a trend indicating moving average of a stock price that presents the difference between two moving averages. The bullish signal is given when the MACD line moves above the signal line while the bearish signal is given when the MAC line is below the signal line.
- Bollinger Bands
Bollinger Bands consist of a moving average and two standard deviation lines. They expand and contract based on market volatility. When prices move outside the bands, it can signal that a stock is overbought or oversold.
- Fibonacci Retracement
Fibonacci retracement levels are the horizontal lines that represent vital levels at which support and resistance are expected to occur. These levels are derived from the Fibonacci numbers and are used to estimate the possible reversal points in the market.
- Chart Patterns
Chart patterns like head and shoulders, double tops, and flags are visual representations of price movements that can signal future market behavior. Recognizing these patterns can give you a heads-up on potential breakouts or reversals.
Common Mistakes in Technical Analysis
1. Overcomplicating the Analysis
Beginners often fall into the trap of using too many indicators at once. This can lead to analysis paralysis, where you have so much information that you can’t make a decision. Stick to a few key indicators and master them before adding more to your toolkit.
2. Ignoring the Big Picture
It’s easy to get caught up in short-term price movements and forget about the overall trend. Always keep an eye on the larger time frames to ensure you’re trading in the direction of the main trend.
3. Not Managing Risk
No matter how good you are at technical analysis, there’s always a risk involved in trading. Set stop-loss orders and never risk more than you can afford to lose on a single trade.
Conclusion
While technical analysis works for traders in some way it does not work like a magic formula. The discovery takes time, perseverance, and the acceptance of trial and error as part of the process. When you grasp the concepts explained in this article, you will be in a position to make better trading decisions. To know more about how to pick stocks for long term considering these indicators, you can visit the best stock market advisor in India – Jarvis Invest.