Technical Analysis

Time to get technical with Technical Analysis.

What is it?

Unlike fundamental analysis, which looks at a company's financials and market position to determine if its stock is undervalued or overvalued, technical analysis focuses on the price action to predict future movements with a high probability. By using technical charts to identify a stock's strengths and weaknesses and reviewing its history of price action, trends, and volume, traders use technical analysis to predict its movement in the short term.

Two Main Types of Technical Analysis

  1. 1.
    Chart patterns
  2. 2.
    Statistical Indicators

How is it used?

The data collected through technical analysis is used to predict the outcome of a trade, at a given time, without bias.
Day traders trying to capture short-term profits between the opening and closing bells of the market use technical analysis to do so.
Swing traders use it to monitor price changes and identify trends over a more extended period of time.
Portfolio managers use technical analysis alongside fundamental analysis to identify investment opportunities for their clients.
Generally, any investor who uses technical analysis is trying to maximize their return on investment.

4 Basic Principles of Technical Analysis

  1. 1.
    Markets alternate between range expansion and range contraction
  2. 2.
    Trend continuation is more likely than reversal
  3. 3.
    Trends end in one of two ways: climax or rollover
  4. 4.
    Momentum precedes price

The Bottom Line

Technical analysis has the same limitation as any strategy based on particular trade triggers: the chart can be misinterpreted. For example, the pattern may be predicated on low volume, or the periods being used for the moving averages may be too long or too short for the type of trade you are looking to make.
Leaving those aside, the technical analysis of stocks and trends has a fascinating limitation unique to itself. As more technical analysis strategies, tools, and techniques become widely adopted, these have a material impact on the price action.