May 19, 2013

A brief introduction to Technical Analysis

Technical analysis is the study of price using charts in order to "anticipate" their future performance.
I have deliberately used the word "anticipate" rather than "forecast" or "predict". The market can go up or down at any time; it is only the probability (of each move) that varies.

Technical analysis isn't a crystal ball that predicts the future, but it is an investing strategy that helps you spot stock patterns that have the potential to make huge moves.

Sentiment drives the market
The price at which an investor is willing to buy or sell depends primarily on his expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to fall, he will sell it.

As any trade requires a buyer and seller, it automatically means they have entirely opposite views on the stock.

The collective majority of market participants ultimately decides the direction of the stock price and the market. Finally, whichever you look at it, price is matter of demand and supply and nothing else.
Fundamentals don't matter
Greed and fear is what moves the market up or down. If the markets are bullish, even a stock with no fundamentals (penny stocks) will rise and give good returns. But if markets turn bearish, then even stock with good fundamentals will crash.
Price reflects everything
Price is a function of demand and supply and nothing else.

The price of a stock reflects everything about the stock. This includes FII inflows, analyst reports, balance sheets, impact of crude and interest rates, govt policies, politicians and their antics and whatever you may care to add.

Different people have varying degrees of access to this information and form their own perception (rightly or wrongly) - this ultimately decides the current price of the stock.

Since everything about a stock is reflected in the price, it makes sense to study price movements. In other words, "what is happening" is more important than "why it is happening".

Trying to identify the "why" is an exercise in futility. One can arrive at any number of reasons depending on how many "experts" you choose to listen to.

The beauty of technical analysis is that it applies to all time frames (intraday, daily, weekly, monthly charts) and across equities, commodities (rice, gold, crude oil, aluminium etc).
Technical Analysis is not 100% accurate
Technical Analysis should not be used to make predictions because we never know the outcome of a particular pattern or series of events with 100 per cent certainty.

Money is never made because of accuracy - the best traders are rarely right even half the time... they make money because they cut losses fast and hold to winning positions as long as required.

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