In an unusually volatile equity market, investors and analysts often use 'technical analysis' to read the market and capture the possible ups and downs in the weeks to come. While it's a vast, often complicated, branch of finance literature, a basic understanding of the subject could be useful to all investors in stocks.
What is technical analysis?
Technical analysis is a method to predict the future behaviour of securities, with the use of past data. Such data can cover a wide range of variables, from prices to volumes generated in a particular security.
Technical analysis is primarily associated with stocks, but this can be used for quite a few types of securities. The data and analysis using several parameters are then used to take a call on future prices of securities.
How is technical analysis different from fundamental analysis?
Fundamental analysis is one of the most common methods adopted by market analysts to predict future prices.
Fundamental analysis concentrates on the company's financials, changes in these numbers, along with future performance forecast to arrive at an expected share price for the company. As against this, technical analysis uses existing data and previous behaviour to arrive at possible future movements of the price.
What is the basic premise that technical analysis is based on?
Technical analysis is based on the assumption that historical performance or behaviour is a strong indication of the future performance or behaviour. The belief here is that securities move in predictable ways or trend and in the process they create patterns. All these will continue to occur unless there is something that will change this trend or pattern. And till that point of time, one can use the past actions for the prediction.
The people who do such analysis are called technical analysts; they use sophisticated software to arrive at their observations. In many cases, there are traders who only use this for the purpose of their stock decisions. However, there is a perception that a mix of fundamentals and technical analysis could prove more beneficial to investors.
What are charts in technical analysis?
The data collected on a particular stock are converted into different kinds of charts, which are then analysed to arrive at a view on the price movement of the scrip.
There are different kinds of charts; the common among these is the bar chart – represented by bars to represent the opening, high, low and closing prices for the day. The bar chart is more illustrative. Another common tool is the candlestick chart, illustrated by rectangular boxes, which indicates the opening price and the closing price with the range during the day. If the opening price is higher than the closing price, the rectangle between the two is shaded. The tool owes its origin to a 17th century Japanese technique.
What are some of the other popular indicators?
While choice of tools vary with analysts' preference, there are some common ones used by all of them.
Calculating the moving average for different time period is a widely used technical indicator. However, it's often combined with other calculations.
There are convergence, divergence or exponential moving average.
Then there are support and resistance levels, which are lines on chart to indicate the levels at which the stock price will find some support against a drop or face resistance while moving up.
Some of the other tools are Relative strength indicator, Elliot wave theory, Fibonacci lines, Williams %R etc.
