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You might have come across the term technical analysis countless number of times. This word fascinates most of us but very few of us actually know what technical analysis is. The term Technical Analysis means the anticipation of the general direction of Current Market Prices (CMP) of various stocks using past market data. It is the source of identification of trading techniques and opportunities based on the movement and reaction of other market participants. In this article, we will be covering all the basics of technical analysis, the knowledge of which you would require as a professional trader or a student.
When Should You Use It?
Those who are short-term traders and trade stocks on an intra-day basis use technical analysis more frequently. Day traders and swing traders make use of technical analysis of a stock the most often! Technical Analysis helps in identifying short-term trading opportunities for making profits while investing or trading.
Investors only use Technical Analysis to calculate the entry point of the stock and to determine the exit price. The entry point refers to the price at which the investor/ trader should buy a stock, which would help him to make more profits. The exit price refers to the price at which the investor/ trader should sell a stock and book profits without taking further risk of holding it for a longer period. Both entry and exit points need to be determined by any investor/ trader before taking any kind of position in the stock market.
However, I would like to say that both technical and fundamental analysis are equally important if you want to gain success in the stock market.
Basis of Technical Analysis
When we are talking about Technical Analysis, we are talking about the study of two things, Price & Volume. Let us understand both of them in detail.
Price: The price of the stock is the Current Market Price at which the stock is trading. The historical price of a stock helps in determining the current trend of the stock. Trends tell you the most about a stock. We will be discussing trends in the latter half of the article. Make sure that you stick with me until the end so that you do not miss out on such an important aspect.
Volume: The volume is basically the quantity of shares that have been traded at a particular point of time. It represents the number of times a stock changed hands during a particular period. When you open a chart of any stock, you will be able to see the volume at the bottom of the chart. Quantity or volume actually confirms if there was a meaningful price movement to a stock. If the price is backed by volume, then it assures us that the change in price might be meaningful.
What is a Chart?
Technical Analysis is all about price and volume. We can come to know about trends using historical prices of a stock. All this information about prices, volumes, trends and indicators is represented through a chart. A chart is a graphical representation of historical prices of a stock. A chart represents the flow of prices during a particular period of time. The upper half of the chart shows the movement in prices and the bottom of the chart shows the volumes at which the stock was traded at a particular point of time. Charts are the base of technical analysis. Many traders execute trades and book profits just by looking at charts.
Different types of charts:
A line chart is a chart which represents the connection of various historical prices of a stock using a continuous line. It doesn’t show much information to the trader. It helps in easy identification of trends.
Bar chart connects historical prices using several bars of different lengths. The lengths of these bars depend upon the price movement in a particular period.
These are the primary charts used by all the traders. These charts represent historical prices through candlesticks. This is the most useful chart type and helps traders in identifying lots of useful information.
What is a Candlestick?
A candlestick is a very useful means to display the open, high, low, and closing (OHLC) prices of a stock. Because they contain so much information, candlestick charts are widely used by technical traders. The body of the candle is the hollow or filled portion. The long thin lines called the shadow depict the highs and lows.
A hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body, if the stock closes higher than its opening price, representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price.
Each candlestick represents a certain time period. We can classify candlesticks on the basis of time period. For example, there are 1-minute, 5-minutes, 1-hour, & 1-day candlesticks.
Market Sentiment is the comprehensive attitude of all the investors towards the securities market. It represents crowd psychology. It is determined using the price action and movement of a stock. It is a major part of technical analysis. Day traders and technical analysts rely on market sentiment, as it influences the technical indicators and chart patterns which they utilize to gain profit from short-term price fluctuations. There are two types of market sentiments:
The market sentiment is said to be bearish when the prices are falling and the bears are in the lead. Bears are all those traders who believe that the market is weak and the stock prices are going to fall. They earn profits by going short on a stock.
What do you mean by going short? Profits can be earned by borrowing a stock and selling it at a higher price and then buying it back at a lower price when the market has fallen. It is also known as short selling. It is a practice adopted by bears when they believe that a market fall is near.
The market sentiment is said to be bullish when the prices are rising and the bulls are in the lead. Bulls are all those traders who believe that the market is strong and the stock prices are going to rise in the future. They earn profits by going long on a stock.
What do you mean by going long? Profits can be earned by buying a stock at a lower price and then selling it at a higher price when the market is up. It is a practice adopted by bulls to earn profits when they believe that the market is going to rise in the near future.
What is a Trend?
Trends are the core of Technical Analysis. They are structured through the movement of prices in a particular direction. The principle of Technical Analysis is that prices move in trends and history tends to repeat itself. A trend is the direction in which the prices are moving.
Different types of trends:
When the stock prices move in a downward direction, it is said that the stock prices are showing a down trend. It means that the current high is lower than the previous high and the current low is lower than the previous low. It demonstrates lower highs and lower lows. It represents a bearish sentiment in the market.
A stock is said to be moving in the side trend if the stock prices move sideways. It means that the prices fluctuate in a particular range. It represents that neither the bears nor the bulls are in power.
When the stock prices move in an upward direction, it is said that the stock prices are showing an up trend. You can interpret that the current high is higher than the previous high and the current low is higher than the previous low. It demonstrates higher highs and higher lows. It represents a bullish sentiment in the market.
You can see an example of the three types of trends in the snapshot of the chart which I have attached. The first trend is a down trend since the prices are moving in the downward direction. The downtrend is followed by the side trend/ the range which is followed by a relatively bigger up trend.
Concept of Support & Resistance
When you have a glance at a chart of any stock, you will observe that the price of a stock doesn’t fall below a certain level and the price doesn’t rise above a certain level. This takes us to the concept of support and resistance.
Support means something that upholds and supports the price of a certain stock and doesn’t let the price fall below it. Every time the stock price goes down and hits the support price, the price bounces back off it. The support forms the base for the price of the stock.
Resistance is something that the price cannot go through. It combats the price when it hits a certain high price. Every time the stock price goes up and hits the resistance, the price doesn’t break through the resistance level.
The support and resistance helps in maintaining volatility and speculation and keeps the price of a stock within a certain range.
You will understand this concept better from the diagram below.
The green line represents the resistance price for the stock, i.e. 120 and the red line represents the support price for the stock, i.e. 115.
Technical Analysis using MarketXLS
MarketXLS provides various useful tools and functions for execution of trades using technical analysis. There are hundreds of functions which you can use to find the daily prices, volumes and other technical aspects of the stock. Here, I have attached a snapshot of how the software helps in the execution of trades through technical analysis. You can avail the technical analysis functions through the ‘Technical Analysis’ section of the ‘MarketXLS’ tab.
You will come to know more about how to use MarketXLS for the execution of technical analysis in the next few blogs of the series. There are various technical indicators and chart pattern recognition functions and formulas using which you can take your trading decisions.\
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