Definition: We define technical analysis as the tracking and investigation of how the price of a given tradeable asset moves, whether up or down and the size of deals associated with each movement.
It is the examination of the trading activities associated with a particular tradeable asset in the market, which includes stocks, options, ETFs, Index Funds, etc.
Essentially, the term technical analysis is the study of the price movements and volumes of trade extracted from previous transactions in other to reach investment decisions by investors.
The data and trends identified from these existing records about previous trading activities of an individual stock for instance, helps investors determine or predict a possible direction for the stock in the future.
This is basically, what technical analysis underscores in the investment world. It defers essentially from fundamental analysis, which on the contrary looks at the fundamentals of a tradeable asset or security.
Such fundamentals include the company behind the security, the strength of its management, its financial statement, future plans, the sector or industry of operation, etc.
Basic Facts
- Technical analysis is a way of using price movement to decide if a security is worth investing in, by looking at existing records of previous trading activities of the particular security.
- The major factors in technical analysis of a security are two – the past price movement and the volume of trade for each deal.
- Technical analysis is one of the options available to investors while evaluating any security or tradeable assets in the marketplace. Fundamental analysis is the second option.
- Technical analysis defers from fundamental analysis in the sense that the former only looks at trading activities, while the later looks at everything about the stock.
- Technical analysis seeks to determine how the price will move in the future, whether it is likely to go up or come down. On the other hand, fundamental analysis is seeking to determine what is the actual value of the stock and if the current market price represents the true value of the security (fair price).
- Technical analysis assumes that a particular security under review is already trading at its fair price in the marketplace.
Background
Investment decision is not made on emotions. It is made on facts and figures extracted from available data about the security. Professionals involved in this decision making are analysts who understand how to extract and apply both technical and fundamental essentials from these securities.
In carrying out these analyses these professionals, use various options, formulas, and charts to interpret trends and make projections with them. Technical analysis is only one of the multiple options available to investors to analyze and reach investment decisions.
However, it is only available for securities with existing data about trading activities. Consequently, most securities can be subjects of technical analysis as long as it is not a new listing in the market. This includes company stocks, currency pair, index funds, bonds, etc.
Another analytical vehicle available for investment decisions used by investors is fundamental analysis, which we have briefly discussed above. Investors who use technical analysis assume that credible fundamental analysis have already been done on these securities in the past to determine the prices associated with the previous volumes of trade.
This trading volume and the price for each deal is essentially considered from the same prism as the law of demand and supply.
Investors who adopt technical analysis proceed from the believe that the security is already trading at a fair price, which has factored in all relevant fundamentals of the security, including the financial statement, management, industry, and other relevant factors that directly and indirectly affects the security.
Therefore, the promoters of fundamental analysis hold that what is left for the investor is to track previous price movement of the security and the trend, patterns and signals it creates, in other to project how the security could perform in the future.
By looking at the prices (supply side) and volume of trade (demand side), an investor can take an informed position if it is believed that the security could sustain any bullish/upwards price movement identified in the trend.
Where the trend does seem to be weakening or may weaken in the near future, which may result to fall in price, and then investors may decide to offload the security and cash out before the downward price movement happens.
Investors who are in the market for short-term profit taken are known to rely on technical analysis to ply their trade.
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