If you’re just starting your journey in stock trading, you’ve probably heard of the term “technical analysis” here and there. Every article seems to mention it, but what is it exactly, and why is it so important?
Well, in this short guide, we’ll take you through the specifics of technical analysis in stock market trading to help you maximize your profits and become a successful trader in no time whatsoever!
So, without any further ado, let’s get right to the bottom of it!
According to Treasuredcap, the basic principles of the technical analysis method in stock trading stem from hundreds of years of research on financial markets. The concept we know and use today was introduced by Charles Dow nearly 250 years ago. It was further developed and refined by Robert D. Edwards and John Magee in 1948 through their famous publication “Technical Analysis of Stock Trends.”
So yes, technical analysis has been around for some time now, and it still has a massive impact on how we trade stocks today. It’s something every trader needs to learn to find success in the stock market. With that being said, stock markets are susceptible to change, so keeping an eye on new trends and applying your technical analysis knowledge to the current state of the financial market is the best way to go about it.
The three basic assumptions of the Technical Analysis method:
While Charles Dow set the basic assumptions of this theory (the market moves in identifiable patterns over time), they’ve been updated and specified more closely over the last few decades. Today, professional traders seem to agree on three basic principles for the entire discipline:
1. The market discounts everything
Technical analysis presumes that everything that affects the company is directly connected to the price of their stocks. That includes both company fundamentals, market psychology, and other economic factors that determine how the stock price is formed.
2. Price follows trends
Treasuredcap also pointed out that stock prices tend to pick up long-term market trends and follow specific patterns quite consistently. That is precisely what technical analysts assume and follow to find the most optimal trading options available.
3. History repeats itself
Lastly, technical analysis assumes that price movements show repetitive patterns over time. That is mostly attributed to market psychology, as consumers tend to show similar reactions to the same type of market stimuli. So, yes, price movement on the stock markets is quite repetitive, especially when it comes to long-term trends.
These three postulates are what the entire discipline is based on, so make sure you know them by heart! Of course, these are just basic explanations, so take them as a simple introduction into technical analysis, nothing more.
Technical analysis and price charts:
The primary tools all technical analysts use are the various types of price charts. They all measure price movement in an attempt to predict future fluctuations, the only differences being the timeframes and financial indicators used. The most common timeframes used for plotting these charts include:
- 5 minutes
- 15 minutes
- 1 hour
- 4 hours
- A day
Now, the timeframe you choose should suit your trading style. If you’re a day trader, you’ll benefit from shorter timeframes such as those found in 15-minute charts. On the other hand, if you prefer holding your trading positions for more extended periods, you should opt daily or even weekly timeframes in your analysis instead.
When it comes to technical indicators used in this method, the most common ones are:
- Price trends
- Momentum indicators
- Moving averages
- Resistance levels
Different indicators should be used for various needs and trading styles, but moving averages are a great place to start. The indicator tracks price movement and helps you determine whether a stock is worth investing in or not.
Again, technical analysis can be pretty complex at times, so educate yourself and read as much as you can before you start trading on the stock market. Places like this website can provide you with tons of valuable resources for learning and applying the technical analysis technique to your trading strategy.
Advantages of using this method in your trading routine:
One of the best things about this particular analytic method is that it can be used for getting quick and precise data in a matter of seconds. You won’t need to wait for weekly or monthly financial reports just to make a conclusion about the state of the market. You can also observe the effects of many economic factors, including market psychology, supply, and demand, in a brief timeframe, which is impossible to achieve via other analytic methods such as the fundamental analysis technique.
So, if you’re an intra-day trader and you care about short-term changes on the stock market, this method is your ticket to success.
Drawbacks and limitations.
Unfortunately, not a single financial indicator is always 100% accurate. Technical analysis requires a large number of trades to be effective, and sometimes it can be hard to get a conclusive picture out of it. Many newbie traders make the mistake of overly relying on historical data without paying attention to other significant factors covered by the fundamental analysis method. That’s why we suggest you use different analytic tools to get to the optimal solution: fundamental and technical analyses are the best when they’re combined.
Overall, this method works the best for short-term stock investments. Otherwise, it can be pretty misleading. Learn how to spot the warning signs that the trend might not be as consistent as it seems, and be prepared to lose sometimes. Stock trading is always risky, and no amount of technical knowledge can altogether remove the risks involved. With that being said, however, you can continually improve your profitability and learn from your experiences to become a better trader by using these analytical methods.
The bottom line
Technical analysis is a helpful method widely used in stock trading. Its main goal is to help you predict price fluctuations on the market and make better decisions along the way. Like any other type of analytical tool, it has its pros and cons, so make sure you’ve done your research before you start applying it to your own trading strategy.