Stock analysis is the basis of making an investment decision for any investor or trader. It involves the study of the company’s stock on a macro as well as micro level. There are two basic types of analysis that are required while making an investment decision related to stock namely, fundamental analysis and technical analysis. Fundamental analysis is analysis of the core financials of the company while technical analysis is the analysis of the price movements of the stock as well as the market trends.
Given below are the meaning and relevant details related to the technical analysis of a stock.
Technical analysis is a study of the movement of the price of a stock based on the core functions of its demand and supply along with the current market trend that influences its prices. It requires a great understanding of the technical aspects and tools relevant for such analysis like charts, candlesticks, timely prediction of market trends, etc.
Technical analysis is based on a few core assumptions. Undervaluation and overvaluation of the stock is irrelevant in the case of technical analysis of stocks. It only considers the relationship between the price and volume of the stock and its future impact on stock prices. Some of the core assumptions of technical analysis are detailed below.
The basic assumption of the technical analysis is that the price of the stock accounts for all the information whether available to the public or not. For example, the promoters or competitors of a company may be buying or dumping the shares of a company on account of some sensitive information that is not available to the public at large. However, technical analysis assumes that such huge volumes of buying or selling of the stock are reflected automatically in its prices. Technical analysts, therefore, argue that the fundamental analysis of a company is not as relevant as the share prices are all indicative.
Another important assumption is that the price of a stock moves in trends. The share price of a particular stock cannot be random and the movement of the stocks is always in correlation with the current market trend.
Technical analysis assumes that the psychology of the investors plays a huge role in the price movement. It assumes that stocks follow a fixed pattern in price movement which is driven by human psychology. In a falling market, the majority of the participants will sell their holdings irrespective of the profit or loss they make to exit the market and vice versa. This movement is consistent over the past multiple decades and hence the assumption that history repeats itself is quite true in respect of technical analysis.
The most common and important tools used in technical analysis are detailed below.
Charts are in relation to the price and volume of a particular stock. The volume chart reflects the number of shares of a particular stock that are traded on a given day. The price chart on the other hand reflects the movement of the price of the share. The candlesticks are a unique type of chart that reflects the price and volume movement for a fixed duration like 5 minutes or 10 minutes or as per the preference of the investor or trader. Charts and candlesticks are the basic tools for technical analysis used by traders and investors.
Indicators are mathematical calculations based on statistics and are used to indicate the basic entry and exit points for an investor or a trader. Oscillators are indicators used in a short span of time to indicate the factors and conditions for the entry or exit from the market or trade positions.
Moving averages are the graphical representation of the average movement of the price to indicate the current trend. This allows the investor or the traders to make a careful analysis of the sharp upwards or downwards movement of the price of the stock. Moving averages are used to reflect a relatively longer duration of price movement (for example a month) rather than the daily average.
Technical analysis and fundamental analysis are different aspects of valuing an investment that can help investors or traders make informed decisions. Some of the basic differences between the two are.
| Category | Technical analysis | Fundamental analysis |
| Meaning | Analysis of the past and the current price and volume movement of the stock to assess the future trend of the stock. | Analysis of stock based on financials and micro and macroeconomic indicators |
| Use | Technical analysis is used as a short term approach i.e., in short term investment opportunities or trade positions. | Fundamental analysis is used as a long term approach i.e., in long term investment opportunities or trade positions. |
| Relevant to | It is relevant for traders | It is relevant for investors |
Technical analysis is an effective tool especially for traders to make prompt decisions based on market trends and the movement of stock prices. It requires a thorough understanding of various tools relevant for such analysis as well as understanding the core principles to make a sound investment strategy.
The most common tools used in technical analysis are trend lines, moving averages, support and resistance, charts and candlesticks, indicators, and oscillators.
No. Technical analysis is most effective in building a short term portfolio and tracking short term trade positions.
The basic limitation of technical analysis is the bias of the analysis that the price of a stock is the only relevant factor in the decision-making process. Price is influenced by a number of factors and the market trends or market sentiments cannot overlook or forego the need for backing or strong financials.
The two approaches of technical analysis are the top-down approach (the focus is on the economy followed by the industry that the company belongs to, and finally the individual stock) and the bottom-up approach (focus is the individual stocks followed by its industry and finally the economy as a whole.
The general steps to be followed in the technical analysis by most traders are,
-Analysis of the indices
-Analysis of the target sector
-Analysis of the stocks at the individual level.
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