Should I buy today? Will I get better prices if I buy in the future? At what point should I exit? If you have these questions in mind then technical analysis could provide answers….. 

Those “in the know” on Dalal Street have increasingly turned to technical analysis (TA) in recent years. They understand that stock prices don’t move randomly, rather they move in repetitive and identifiable patterns. They use this know-how to gain an edge over other investors and make money in the stock markets. This is the first article in a series on TA that could help you in using technical analysis and in turn anticipate what is "likely" to happen to prices over time. 

In order to understand TA better, its important to know the foundations on which TA is built - 

Principles of TA

Every thing is discounted and reflected in market prices

According to TA , all fundamental, economic , political , psychological or other information is reflected in the stock price. For eg. A technical analyst (one who uses TA) is not bothered about bottom line growth, intrinsic value, dividend yield or price-to-earnings ratio, which are of great importance to a fundamental analyst, rather a technician believes that the real value of a stock at any point in time is determined only by supply and demand as reflected by the charts. A technical analyst doesn’t bother about the underlying forces that are responsible for changes in demand and supply. Rather, he /she is only concerned about the current price and the history of price movements, which in turn forms the basis on which he/she takes buy/sell positions in the market. In short, technical analysts focus on “what” rather than “why”.

Price tends to move in trends

Market prices move in one direction, up or down, creating a trend . That trend persists until the price movement reverses and starts moving in the opposite direction. A technical analyst believes that it is possible to identify a trend, invest based on the trend and make money as the trend unfolds. Because technical analysis can be applied to many different time frames, it is possible to spot both short-term and long-term trends. 

Market action is repetitive

Basic human nature does not change and hence, it tends to react to similar situations in a consistent ways. For eg., whenever there is a stock market crash, the price of gold invariably shoots up as investors’ aversion to risk takes center stage. Since the market price is a reflection of human greed and fear, technical analysts study it to determine how people react under certain conditions, which in turn gets reflected in the chart patterns and thus, anticipate future stock price movements.

 

TECHNICAL ANALYSIS – A STUDY OF DEMAND AND SUPPLY 

TA is the process of analyzing a stock’s historical prices in an effort to determine probable future prices. In other words, TA is a study of demand and supply using charts. If buyers are more than sellers, the demand for the stock is greater than the supply and the price goes up. If sellers are more than buyers, the supply of the stock is more than the demand and the price goes down. This contest between buyers and sellers is recorded in a chart form showing price and volume activity. TA is a study that interprets the charts and provides us with insights on the probable trends in prices.                                                                                            

Since TA is the study of price action, it can be applied effectively to analyze stocks, bonds, futures, options, commodities and other forms of investments for buy/sell opportunities across time horizons (either from a short–term or long–term perspective).

 A brief outline on TA, the principles governing TA , were discussed in this article . In next few articles, we will focus on types of charts, impact of volume and open interest, drawing trend lines and more….