Understanding Technical Analysis | A Complete Beginner’s Guide (Part 2)
We know that Technical Analysis (TA) is one of two key methods of evaluating stock prices and the market in general. TA is a statistical way of foretelling future price movements based on a review of past or historical data. Technical analysts specialize on two things – reading charts and viewing trends. You can level up your stock trading skills if you have an understanding of technical analysis.
With TA, investment decisions are based “exclusively” on what the charts say. Technical analysts believe that charts carry more weight than fundamentals. However, the predictions based on stock charts may sometimes turn out to be inaccurate. It’s analogous to how a weather forecaster can occasionally commit an error.
Anticipating future price and market movements
If you’re not too keen on going over financials, cash flows, earnings per share, and other relevant financial stuff, technical analysis is your other option. Greenhorns in the stock market would take longer to get into the swing of things. One has to get acquainted with the terminologies and know exactly what they mean. But once educated, stock trading becomes visually interesting.
Basically, it’s like learning a new language but in a statistical sense. Technical analysis uses various charts to guide stock traders and investors. From these charts, a trader can refer to past records, recent and ancient. A trend can be recognizable and a longer trend line can be established. Thus, it gives the confidence to assume a likely stock action.
Trends and Trend Lines
Trends and trend lines buoy the adrenaline of technical traders. By performing trend analysis, a trader can ascertain the direction or price movement of a stock. The odds of a successful trade lean in favor of the trader.
Defining a trend
When you talk of a trend in the stock market, it simply means the general direction of a stock price or the market index as they move over time. A trend can vary in length – short, medium, and long term.
When a stock price is rising, it is on an upward trend. In the broader sense, when an index is trending upward, it means the market is on a “bull run.”
Figure 1: Strait Times Index (STI) – YTD Chart as of 01-24-2018*
Looking at the trend line of the Strait Times Index (STI), the blue-chip index is off to a great start in 2018 and currently moving on an upward trend.
When a stock price is falling, the downward trend raises a red flag. Whenever the market is trending downhill, the market is experiencing a “bear market.”
As an example, the stock price of GSH Corp. Ltd. (GSX) is generally on a downward trend since the year started. It is a publicly listed company in Singapore engaged in property development in Asia.
Figure 2: GSH Corporation Ltd. (SGX: BDX) – YTD Chart as of 01-24-2018**
An interesting trend in the stock market is the sideways trend. The trend occurs when the supply of and demand for a particular stock are just about equal. In the equities lingo, it’s also known as the horizontal trend.
This third trend is not rare but it lapses after a brief spell. The stock price is flat and moving along a horizontal line before the next round of price spikes and dips resume.
Defining a trend line
In order to show the prevailing tendency or direction of a stock price, a line is drawn over pivot points, either highs or lows. The result is called a trend line. More or less, the trend line is an accurate presentation of support and resistance to a stock in a given stretch. A trader can visually make out the direction, speed of price fluctuations, and also see the developing pattern during times of price contractions.
Support and Resistance in the stock market
Trends are vital when it comes to the identifying the levels of support and resistance of a stock’s price. Support and resistance are special terms used by technical traders. These two concepts form the foundation of technical analysis.
Figure 3: Support and Resistance
Technical analysts are very particular about support or support level. Support in the stock market jargon refers to the price level below which a stock price has had difficulty sliding historically. It is usually at this level that traders tend to take a position and purchase the stock.
When the price slides and approaches the support level, the stock is being tested. Either the support will hold or about to be penetrated. If the price drops further, the support line is breached. Thus, buyers move in for the bargain. The stock recovers and its price starts to rise again.
Resistance or resistance level refers to the line or level a rising stock price can’t surpass or overcome. Similar to the support line being broken, the resistance line can also be breached.
When a soaring stock reaches the resistance level, the trend generally reverses. Brisk selling follows as traders starts cashing in on profits. In this instance, selling subdues the buying mode.
Support and resistance levels are considered as trend lines too. Connecting two or more recent stock price lows on a stock chart would produce an important trend line. The same thing goes for resistance. You draw a line and connect two or more recent high prices. Interestingly, a breached support line can act a resistance and vice-versa.
Stock trading follows a certain market psyche. When the support level is breached and the stock price reaches the lowermost level, bargain hunters come in. On the other hand, a selling spree occurs when the stock price reaches the highest level and profit takers seize the opportunity.
Fundamental analysis and technical analysis have the same objectives – profits. However, the main difference is that the latter is purely technical. Stock charts and trend lines are the obsession of proficient chartists. They track stock prices and monitor trend lines before making a move. That’s a widely embraced aspect of technical analysis.
Bear in mind that this method of evaluation is not the be all and end all approach to stock investing. But it’s one of the excellent tools when buying or selling stocks. Or finding the correct timing when to enter or exit a trade. By learning this strategy, you can be a well-rounded player in the stock market sphere.