Technical
Analysis
of Stock Market
Technical analysis of stock market has been more and more popular. This type of analysis is perhaps the most widely used tool designed to help the investor beat the market.
Although Fundamental analysis does play an important part in selecting winning stocks, most investors nowadays will not leave out technical analysis altogether.
- What is technical analysis?
- The Dow Theory
- What does technical analysis comprise of?
- Charts
- Chart Pattern
- Volume and Open Interest
- Trend Analysis
- Trend Lines
- Support and Resistance
- Japanese Candlesticks
- Moving Averages
- Oscillators
- Elliot Wave
- Fibonacci
- Intermarket Analysis
- Sentiment Analysis
- Breadth Internal Analysis
- Market Internals
What is technical analysis?
According to John Murphy in his book Technical Analysis of the Financial Markets, technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends.
Technical analysis of stock market is based on the theory that market prices display repetitive patterns. The price pattern repeats itself because of the never changing nature of human beings. We are controlled by the emotions of fear and greed and we never learn from our mistakes. One good example of this is discussed in the Stock Stages article.
As market prices display repetitive patterns, the technician can study what has happened and market activity such as past price and volume to forecast what is going to happen in the future.
This is something like looking at the rear mirror of a car to see where we are going next. However, unlike the situation of the car, many investors and traders have been able to make extraordinary profits trading the markets using technical analysis.
The Dow Theory
Technical analysis of stock market can be traced back to articles published by Charles H. Dow in the Wall Street Journal between 1900 and 1902. Although more than 100 years old, the ideas and theory by Dow is still relevant today and forms the foundation of modern technical analysis.
Some of the tenets that Dow laid down are the averages discount everything and the market has three trends. For more on the Dow Theory and what it is do read the discussion on the Dow Theory.
What does technical analysis comprise of?
Stock Charts
Technical analysis is a vast area of discipline and there are indeed many subcategories in this topic. One of the first things that the student of technical analysis will learn to use is Stock Charts.
Stock charts are the main thing that the technician will see everyday and they come in many forms. For those who do trading, it would be foolish to trade without charts. Which type of charts that the technician use will depend on their preference and affinity towards it.
Chart Patterns
Once you have explored the many type of charts, you should learn about Chart Patterns. Chart patterns are the footprints of money. They work very well because as mentioned, market prices display repetitive patterns. Some of the famous patterns are such as double bottoms, double tops, head and shoulders and the cup and handle patterns.
There are dozens and perhaps hundreds of chart patterns and their variations. It is good to learn as much as you can about them. After learning about Chart Patterns most traders will focus on trading a few patterns and master them. These patterns will be their bread and butter to help them make profits trading in the market.
Volume and open interest
The smart investor and trader also realizes that it is not only enough to learn about chart patterns. They supplement charts and chart pattern analysis with volume and open interest.
Volume is extremely important as a confirmation of the direction of the trend. Volume can also end an existing trend and begin a new trend.
Trend Analysis
This brings us to the next thing that investors and traders should learn in their technical analysis of stock market, Trend Analysis. This is where the maxim 'the trend is your friend' comes true. We know that there is always an uptrend, down trend and sideways trend. Once you have learned about trend analysis, you will be amazed at the many times that you have lost money just because you were trading against the trend.
Trend Lines
Closely related to trend analysis is learning how to draw Trend Lines. Trendlines can appear in an upmarket which is called an uptrendline and they can appear in down markets which is called a downtrend line. Uptrend lines and downtrend lines sometimes act as support and resistance and can offer early clues of whether the stock price will cease to continue in the current direction.
Support and Resistance
The next thing that you need to learn in technical analysis of stock market is the concept of Support and Resistance. Support and resistance is one of the technicals that professional traders always lookout for.
Many trades are entered or exited based on support and resistance. There are also many trading strategies which take advantage of this simple but important concept. The awareness of the support and resistance area in a stock or the indexes will help you to protect your profits and avoid losses.
Japanese Candlesticks
Technical analysis of stock market is about the analysis of price. Even chart analysis and chart patterns are based on what happens to the price of the stock over a few minutes, a few days or a few months.
One popular way to analyze price is through the use of Japanese Candlesticks analysis. Japanese Candlesticks display the price of the stock in a visual form. It is made up of the opening price, the closing price and the tails of the candles are formed by the highs and lows of the day.
As Japanese Candlesticks are so visual, it can give the investor or trader who uses it a real advantage over others. Some, Japanese candlestick patterns offer great clues and can be extremely accurate in showing what will happen in the next few days, weeks or months depending on the time frame used.
For example, the appearance of a shooting star can indicate that the buyers are no longer able to support the stock with the sellers being successful in pushing the stock down. Hence, it is very likely that the stock will go down in the next few sessions. Many stock market crashes are being preceded by the appearance of a shooting star.
Moving Averages
Another useful tool that astute investors and traders always use in their technical analysis of stock market is Moving Averages. Moving averages are actually the average price of a stock over a specified period of time and they are continuously plotted on the chart each day which smooths the data.
The most famous moving averages are the 50 day moving average and the 200 day moving average. One of its usefulness is to determine whether the stock is in a strong uptrend or not.
If the stock is trading above its 50 day and 200 day moving average, the stock is considered to be a strong stock. Many smart investors will not buy a stock that is below its 50 day and 200 day moving averages. Take a read of the Moving Averages article to learn more about the uses of moving averages.
Oscillators
When you begin to learn about technical analysis of stock market , you will surely come across Oscillators like the RSI, Stochastics and the MACD. Oscillators can be very useful in telling us whether the stock is overbought or oversold. They are often used by traders in conjunction with other indicators when trading.
Another great use is when divergences between the stock price and the oscillator occur. When divergences occur, it can give warnings that the price of the stock may soon reverse direction.
Elliot Wave and Fibonacci
Other more advanced technical analysis of stock market that have been developed are Elliot Wave and Fibonacci. Elliot wave theory suggests that the stock market follows a repetitive pattern of a five wave advanced followed by a three wave decline. Elliot Wave practitioners have been quite successful in predicting market turns and thus it will be beneficial to be aware of this theory.
Fibonacci which is closely related to the elliot wave theory can be used to determine price objectives. It is done through the use of percentage retracements. The most common percentages are the 38%, 50% and the 61.8%. What this means is that when a stock retraces after a move, it will usually stop around these areas before resuming its previous move.
Intermarket Analysis
Intermarket Analysis is becoming more and more important in the modern technical analysis of stock market. This analysis is seldom mentioned because only the true professional are aware of its importance. By intermarket analysis we do not mean analyzing the foreign stock markets although that may be beneficial.
What intermarket analysis means is the study of the interlink and connection between the stock market and other markets such as bonds, commodities, sectors and currencies. What happens in other markets can offer clues on the future direction of the stock market and vice versa.
Sentiment, Breadth Internal and Market Internal Analysis
Last but not least, the study of technical analysis of stock market will not be complete without learning about sentiment analyis, breadth internal analysis and the market internals.
These 3 analysis is like X-raying the market. Novices are often only taught to look at the outside of the market, namely what is happening to the price of the Dow, S&P 500 and the Nasdaq. However, what looks good on the outside may not reflect what is actually happening in the inside.
The market may actually be hitting new highs while its internals are rotting away. Sooner or later, the indexes will catch up to its bad internals. This is also where the professional who are aware of the internals will start selling their stocks while the public is busily accumulating shares.
Summary
As shown, the study of technical analysis of stock market is indeed vast. There are no shortcuts when it comes to making money in the stock market. If you are only thinking of getting rich quick, you will not succeed in the stock market. Do not donate your hard earned money, because those of us who work hard are very glad to take them away from you.
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