The Central Postulation
What is Technical Analysis?
The field of technical analysis deals with analysis/evaluation of stocks by studying the statistics/charts generated from past prices of stocks and their traded volume.
Technical analysts work on assumption that a security already carries details about its fundamentals in form of intrinsic value. Therefore, they don’t pay much importance in studying fundamentals of the company. Making use of charts and other tools, they can anticipate the future activity and trends of a stock.
There are various types of technical analysts/traders. While some of them study chart patterns, and employ technical patterns & oscillators others may use combination of the two.
But what is common between them is the use of historical price and volume data. What matters the most for them is the stock’s past trading data. The data is more than enough in guiding them about the future trends of stock.
They can easily make out how the stock will behave under certain conditions if similar kind of trading environment has been witnessed by the stock in the past as well. Looking into its response to the situation, technical analysts devise their strategies.
The three postulations on which study of technical analysis is based:
1. The market discounts everything
As already discussed, price of a stock reflects it fundamentals as well and hence, there arises no need to study the fundamentals of stock separately. Also, technical traders believe that almost all kinds of economic factors and market psychology is embedded in stocks. So, for them a stock can only be valued on the basis of supply and demand theory.
2. Price moves in trends
Technical traders believe that once a particular kind of trend has been put into place, the future price movement of the stock is likely to be in the direction of trend. However, there are cases defying this logic but these exist in very small numbers.
3. History repeats itself
History repeats itself basically in terms of the movement of price. Market psychology gives rise to repetitive price movements. A technical analyst makes use of chart patterns to track market movements and interpret trends. No matter how old the charts are as long as they provide right amount of data to the reader. Patterns in price movements often repeat themselves. You must have heard about the 50 Day Moving Average or 20 Day Moving Average. These terms present you with a trend over ten or four trading weeks respectively.
Technical analysis can also be used with futures and commodities, fixed-income securities, forex, etc other than stocks.
Here in this tutorial we will confine ourselves just to stocks although you may know by now that technical analysis can be applied to other securities as well, other than stocks.