Technical Analysis: Definition, Importance, Benefits & Tools
When choosing stocks for investment, individuals tend to conduct market analysis. This helps them predict future returns and allocate funds accordingly. Now, there are various ways to analyse the stock market.
This blog comprehensively covers one of the methods, namely – technical analysis. Keep reading to know more.
What Is Technical Analysis?
Technical analysis is assessing the stock market using charts, patterns, financial metrics, etc. These tools help investors study moving averages, volumes and price trends and predict the future intrinsic value of their target asset.
If individuals notice an inevitable downtrend or uptrend in a particular metric, they take note of its period. Additionally, they check the stock’s historical data to detect similar trends and to speculate whether they may repeat in future.
Once the trends come into effect, technical analysts will know what to do and buy or sell their holdings accordingly.
Importance of Technical Stock Analysis
Performing technical stock analysis can help you determine the following:
- Intrinsic stock value compared to its market price.
- Ability of an asset to perform in the market.
- Instability of an asset’s price over a particular period.
- Historically persistent price fluctuations.
- Impact of certain micro and macroeconomic events on stock value.
- Trade volumes, resistance and support levels.
- On-going stock market trends.
What Are the Benefits of Using Technical Stock Analysis?
You can consider using technical stock analysis for the following reasons:
- Determining Entry and Exit Points
With the help of technical analysis, you can predict the price trends of your target stocks. This will help determine the correct time to enter or exit the market and book profits from your trades. Time charts and candlestick patterns can be beneficial in this regard.
- Analysing Market Trends
Technical market analysis allows you to predict future market patterns like uptrends, downtrends and sideways trends. Thus, depending upon your analysis, you can plan your trades accordingly to secure gains.
- Understanding Investor Psychology
Conducting technical analysis can also help you understand the psychology of other traders in the market. It can assist you in getting an in-depth insight into their trading activities and the prevailing investor sentiment.
- Detecting Early Signs of Trend Reversal
A significant benefit of using technical analysis is that you can detect the early signs of a price trend reversal. To do this, you can take the help of price volume analysis and square off your positions before your asset prices fall.
- Provides Valuable Market Information
By conducting technical analysis, you can collect much information through support and resistance levels, volatility, chart and candlestick patterns, etc. This will help you take the correct positions and thus build a more substantial portfolio.
Moreover, this type of information is valuable for all types of trading: intraday, short-term, long term and swing.
- Helps Determine Target and Stop Loss Price
As technical analysis helps predict future price patterns, you can set your target and stop loss positions accordingly. Additionally, by doing so, you can set a clear-cut strategy on what you want to achieve per your risk appetite.
What Tools Are Used for Technical Stock Analysis?
Here are some of the tools that you can use for technical analysis:
There are several charts available via which you can conduct technical analysis. Some of the important ones are as follows:
- Candlestick Charts
Candlestick charts provide visual representations of a stock’s price fluctuations. It helps you determine the connection between the opening, closing, high and low prices of a particular stock.
They are really useful in assessing bullish and bearish patterns and predicting price fluctuations in the short term.
- Bar Charts
Bar charts show you the opening, closing, high and low prices of financial assets over a specific time period. These are one of the basic tools that you can use for technical analysis. They usually come in 4 types – Up day, Down day, Inside day and Outside day.
- Line Charts
By using line charts, you can find your target asset’s price history mapped using a single line. It is one of the simplest charts that you can use while doing technical analysis and is your best choice when starting out.
However, one drawback is that, unlike bar charts, they only show your target asset’s closing prices.
- Daily Moving Average
Daily moving average is a trend line that you can assess to determine the arithmetic mean of your target stock’s closing prices within a set time period. This tool can be extremely useful when you want to gain a thorough insight into a security’s price trends.
- Bollinger Bands
You can consider Bollinger bands as a supplement to the daily moving average. They consist of three lines – a lower limit line, an upper limit line with the daily moving average line in between. By analysing them, you can find out the price direction and amount by which an asset’s price has deviated from its moving average.
- Relative Strength Index
Relative Strength Index (RSI) is a type of momentum oscillator that can help you determine the price change intensity and direction of a particular stock. It comes in a range of 0 to 100, where below 30 indicates stocks being oversold and above 70 shows overbuying of the security.
What Are Support and Resistance Levels in Technical Stock Analysis?
When you study technical analysis, you will come across terms like support and resistance levels. The support level is a price point where the asset value stops depreciating during a downtrend and starts rising.
Conversely, during an uptrend, the resistance level denotes the price at which the asset value stops rising and begins to go in reverse. According to market experts, during a downtrend, you can consider selling off your holdings or going short when the resistance level rises.
Whereas, when there’s an uptrend, you can go for a long position, i.e., buy your target asset after there’s a significant fall in the support level.
To sum it up, technical analysis can help you get a clear insight into price trends and conduct profitable trades. However, depending on just one analysis technique can be risky. Thus, experts suggest conducting fundamental and investor sentiment analysis along with technical analysis.
By doing so, you can gain insight into a stock’s performance from various angles and make an informed investment choice.
Frequently Asked Questions
Q1. How is technical analysis different from fundamental analysis?
Ans. In technical analysis, you can predict the price trends of your target asset via charts, oscillators, moving averages, etc. Whereas, fundamental analysis lets you determine the stock’s intrinsic value by assessing the issuing company’s financials.
Q2. What are technical indicators?
Ans. Technical indicators are mathematical calculations that help determine a stock’s direction depending on its volume and historic price. Some examples in this regard are Moving Average Convergence/Divergence (MACD), Accumulation/ Distribution Line (A/D line), Gaps, Head and Shoulders Pattern, etc.
Q3. What is the accuracy level of technical analysis?
Ans. No stock market analysis technique guarantees 100% results. This holds true even for technical analysis. Thus, experts suggest determining stock value with the help of additional analysis techniques to make better decisions.
Q4. What is the importance of volume in technical analysis?Ans. The stock volume refers to the number of shares traded within a day or a particular period of time. It is an important aspect to study while conducting technical analysis as it can help you determine the asset’s previous trends. Thus, experts always recommend analysing both the price and volume while choosing stocks.