If you have read something on trading or any sort of short term trading strategies, you would have come across this term of “Technical Analysis”. If you are still wondering what is technical analysis and its usage is? Continue reading on. It will help you understand the difference between technical analysis and fundamental analysis. If you are new to this space, please read the other articles I have written to set the context.
As this is the first article on technical analysis, this post will serve as an introduction and answer to some of the common questions on the basics of technical analysis. I will be writing some details about the trend analysis. Trend analysis is one of the common methods used by technical analysts to understand the overall trend of the stock market. For the short term and long term. There will be more posts to cover the other methods of technical analysis in the coming days.
What Is Technical Analysis?
Technical analysis is the process of predicting the future price movements in the stock market. Technical analysts use historical patterns or other indicators. This analysis can cover many asset classes. Insights gained from these analyses will help to profit from the market. You can perform some level of technical analysis even when you are a long term investor. This will help you identify unique opportunities according to your investing style.
What Are Technical Indicators?
There are many technical indicators in technical analysis. This includes previous price action, volume analysis and other indicators. These indicators show what happened to the stock price when it hit a certain price level. There are many technical indicators are you can use from the broker’s application. These are also provided in stock research tools like yahoo finance. There is a saying in the technical analysis space as “History tends to repeat itself”. This is why experts call for a market crash when the stock market is at all-time highs and overvalued. It also says that the market is always efficient and it prices the stocks based on all available information.
Common Technical Indicators
There are many technical indicators, Trend analysis, Volume analysis, Momentum indicators and Volatility. Each of these analysis methods uses an array of technical indicators to find out where the market is.
Trend Analysis
Trend analysis is to understand the trend of the stock market and also the stock that you are screening. There is this saying that “Trend is your friend, don’t go against it”. This means that if you bet against the trend, there is a high chance that you will lose money. The trend will tell you if the market is in an uptrend or a downtrend. When the market is in the uptrend, it means that it is in a bullish market. Even in trends, there are short term trends and long term trends, the direction of the market in the short and long term.
Moving Averages
Technical analysts use moving averages in the chart to see what’s the average stock price in the last 50 – 200 days. You can change the configurations of these days in the setting of the indicator. In the below chart, I’m selecting the AAPL ticker which is the stock identifier of the company Apple.
The purple line is for the moving average of the last 50 days. The other colours indicate the other period accordingly. Blueline with the up and down is the movement of the price over the last few years. As you can see, the current price fall below the 50 days moving average. The current price is 168 and the 50-day moving average indicated by the purple colour is 172.62, indicating that the stock is in a downtrend in the short term. However, you can see that the 50-day moving average is above the 100 and the 150 moving average is above the 200-day moving average. This makes the stock in an overall uptrend with a short term downtrend.
You can also draw a trend line by connecting all the high points on the price chart and low points. This will show a visual indication of the uptrend. If the price moves are channelled in an upward direction, that says it’s in an uptrend.
Supports are price points in the chart where you can see that the price has been going up once it hits some price point.
In the above screenshot, I have circled 2 points when the price hit the 200 Day moving averages. Price bounced back and reversed the downtrend. According to technical analyst’s these trends tends to repeat themselves. If you see the 2 circled areas in the chart, it is seen as an attempt to reverse the trend when the price levels hit these important price points. Short term traders will wait for such opportunities and identify such points to enter a long position. Meaning, buying the stock with a target price in mind. Once the target price is met, they may close the position.
Even if you are a fundamental investor who is in the game for the long haul, you can make use of these indicator’s to place your buy orders to accumulate stocks over the long term. Now, if you are consistently investing in a dollar-cost average method, you need not look for these technical indicators. All you will be looking at is possibly the fundamental factors alone.
If your investment style is lump sum investment, you can buy the shares at these support price points to generate great returns.
Resistance is the opposite of support. Once the stock hit’s certain price levels, it tends to reverse its course to go down. As it hits the ceiling. It is because the short term traders place their Target price just around the resistance levels. Most of the time it goes down after touching the price level. When there is a surge in the demand, it usually breaks the resistance level and moves up even further. This makes the price level support for the next time it comes down. Since everyone knows these techniques, they all tend to follow these.
Common Practices In Technical Analysis?
The most important thing with the technical analysis indicators is that you need to use them in combination to confirm your findings on the market movements. You identify a pattern with one indicator, then use a few of them combined to identify a better trade setup. This will improve the probability of the trade being a profitable one. All these can also be applied to a long term investor too. On the occasion of entering a brand new position or adding a new tranche to the existing holdings.
Don’t come to conclusions too quickly with just the usage of 1 indicator. if you do so, there is a higher chance to result in short term losses. For the long term investor with little to no time to watch the market moves these are just noise.
How Accurate Is Technical Analysis?
No one can predict the market accurately over the long term. You can be right with your predictions on one occasion or maybe even a few. But, you will not be able to predict it consistently. If it was possible, all the rich with lots of money will implement systems to outsmart the market. There are many algorithms placing trades and making investment decisions based on data and quantitative analysis. The market is generally driven by the sentiment of the participants. This is why you cannot predict the market and stock movements. There are times when companies release better than expected earnings and profits, Yet the share price tanks. The opposite also happens, companies with no hope or lots of debt can go up in price when there are people to buy up these stocks.
What Is Fundamental Analysis?
Fundamental analysis is intended to analyse how fundamentally sound is an investment. This looks into the various documentation and ratios available for the company. There are some guidelines on what a healthy ratio looks like and also the overall outlook of where the markets and economies are going. Based on these identified factors, you can analyse the fundaments of the companies. To make money consistently, it is important to invest only in companies that are sound in their fundamentals. If you look a the stock price charts of such companies, you can see that they increase in time. Even if they fall in value during a crisis, these will bounce back up once the clouds are gone.
Who Is Fundamental Analysis For?
Fundamental analysis is used by long-term investors. Short term traders don’t look at the fundamentals in the identification of trade setups. To them, they are using the historical patterns which I mentioned above and the ones I’m going to cover in the upcoming posts. After all, there is too much information available in the world, if you are going to analyse everything, it will take too long. Oftentimes, this will also put you into the analysis paralysis situation. To summarize, fundamental analysis is meant for long term investors.
What To Look For In Fundamental Analysis?
I have written previous posts on how to perform the fundamental analysis. Also created an excel which you can use to populate with your stocks or the stocks you wish to invest in future. There are many factors you need to consider before making investment decisions. Making investment decisions are also like how you purchase anything else. consider what do you look for in a car before you buy land. You will look at the possibilities of the price going up, chances of making some money monthly from the land. If you identify the wrong ones and invest your money in them when you sell them down, you may not be able to fetch a price that breaks even with your cost price.
It is important to thoroughly analyze the companies you are investing in. Quality matters more than quantity. This is why you see that many successful investors have a few stocks in their portfolios.
Is Fundamental Analysis Always Accurate?
Fundamental analysis done correctly will be good then. Fundamentals of companies may change with time. This is expected. Some companies in sectors that are in sectors that are sunsetting will go out of business if they don’t change their business models. This is why the long term investor needs to re-analyze the companies from time to time. Any changes that deviate from your original thesis might need a thorough investigation. If the fundamental changes will harm the future earnings, divest and find other good quality businesses to invest in.
Conclusion
I hope I managed to explain the difference between technical analysis and fundamental analysis. I have written a few blog posts regarding the fundamental analysis. If you are new to investing, it is better to understand the basics before you read further about the technical stuff. In summary, long term investors use fundamental analysis and Traders and short term or momentum investors use technical analysis. When using technical analysis, it is important to look at the different indicators to get concurrence.
You may also be interested in:
