​Key components of a stock technical analysis

Technical analysis of stocks is a methodology used to forecast the future direction of prices and volume (number of investors trading stocks over a given period) based on an observation of past price movements on the stock market. Technical analysts use this method to help traders foresee potential entry and exit levels for trades.

​​A stock market technical analysis involves the study of chat patterns, candlesticks and other statistical indicators such as moving averages.

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​​The role of technical analysis is to predict the stock market behavior and help you decide which stock to buy or sell at best prices with the least risk possible. It also provides traders and investors with very useful information like a stock’s supply and demand on the market, momentum (a measure of today’s stock price compared to the stock price in past days), volatility, traders’ psychology (whether people are selling or buying a particular stock) and early signals of a potential trend reversal. This information allows you to take a position (short or long-term) and start trading.

​​Many factors influence the price of a stock on the market: Inflation, higher interest rates, commodities (oil) prices and political instability (political scandals, war, terrorist attacks and more). These factors can bring a negative impact on stocks market prices: In the first time, they will cause the stock prices to go down and minimize the spending capacity. Secondly, with a low spending capacity, businesses will have a hard time making profits. Thirdly, investors and traders will start selling the stocks in their possession. Lastly, the market will face an imbalance between the supply and demand (more supply and less demand) driving the stock prices further down.

​​Other facts like the financial and operational situation of the company offering stocks will directly affect traders individually. Thereupon, before buying a company’s stock, you must always conduct a thorough study of the company’s business model, their products, how they run daily operations, their partnerships, their recent restructuration or mergers, its past success and failures and what caused them. These factors highly influence the company’s public opinion, at the same time impact the stock demand to go up or down.

​​For example, if a company X experiences a downturn, its image will go down in public opinion, and the value of its stock will decrease. When a stock loses its value, investors or traders will rush to sell, and in result, there is a lot of stock and little demand

​​On the contrary, if the same company comes up with a new and successful product, it is the stock price will subsequently go up and the demand will increase.

​​Market Prices move in trends, and technical analysts believe that the trends tend to be cyclical and repeat patterns; therefore, they use these trends to predetermine whether a current trend will continue or not, or determine when it will reverse.

​HOW DOES IT WORK 

​​To invest in stocks, it is crucial that you take time to identify and analyze the stocks past and current price fluctuations.

​​Certainly, Technical analysis method doesn’t provide accurate predictions, but it sure helps you to anticipate the future (whether or not the stocks of your interest will be beneficial in the future), and make financially responsible decisions.

​Technical analysis of stock follows three steps:

1. It follows market principles or assumptions:

​​The market discounts everything: The method of technical analysis is often criticized as it ignores a company's fundamental factors; instead it only focuses on price movements. However, technical analysts still stand by the fact that a stock's price already reflects all relevant information that has affected or could affect a company. They believe that the stock’s price combined with the market behavior and other economic factors point at everything that has an impact on a company’s business leaving behind the analysis of the price movements. The analysis of price movements consists of evaluating the supply and demand for a given stock in the market, identifying the trend and determines the direction of the price trend.

​​Price moves in trend: Technical analysis method is mostly based on the assumption that a stock's price tends to continue a past trend than to go against it. The trend can be short, medium or long-term.

​​History tends to repeat: This aspect of technical analysis often associates with the market psychology which is very predictable based on traders’ emotions (excitement, fear or hope), also in trading, new investors tend to repeat the same behavior as their predecessors.

​​Based on investors’ emotions, there are two types of market:

​​Bull Market: In a Bull market, investors are optimistic as they expect the price to move upward.

​​Bear Market: In a Bear market, investors lack confidence as they expect the price to move downward.

​​2. It takes into consideration market volume and studies traders and investors emotions over time

​3. It identifies trends by analyzing chart patterns to provide you with a clear vision of a stock’s price movement.

​ KEY COMPONENTS OF A STOCK TECHNICAL ANALYSIS​​​​

There are five major key elements of a stock technical analysis:

​​1. The use of trends: Predicting long term trends is one of the benefits of technical analysis. Trends define the direction in which the market is headed. Trend analysts utilize charts to connect support levels and resistance levels to predict the course of the market.

​​A resistance level is a level at which a particular stock couldn’t reach in the past while a support level is a level at which a stock couldn’t get below.

​​For example, for the last five years, company X stocks were trading at a resistance level of 10$/share and a support level of 6$/share. Luckily, the company realized significant earnings this year, and it's stock's value went above the initial 10$/share; this means that the stock broke its resistance level and this is a good time for you to buy shares as it will typically keep going up. Similarly, if the company receive lousy news that negatively impacts the public opinion, the stock could drop convincingly (lower than the 6$/share) meaning that it could break the support level. At this moment, you do not want to hold a stock that is breaking support level; you can sell it and stop losses.

​​Trends enable you to look at stocks previous lows and highs, at which particular time or under which circumstance has the company peaked or hit the bottom line over time.

​​2. ​VOLUME: As stated above, volume means the number of people that trade over a given period generally a day. Technical analysts measure the rising or falling of stock by the amount of volume behind the movement. For example, if a stock subtly rises from a long-term downtrend, technical analysts will not announce a start of reversal if a large volume does not accompany the stock rise. If the volume is large, then it would mark a beginning of a reversal, and it will appear on the charts but, if the volume is still significantly low, the downtrend will continue.

​​ 3. CHARTS: Charts are a graphical representation of the price movements over time. Their time scale can be yearly (decades before), monthly, weekly, quarterly, daily or even over a period of one hour. There are three types of charts:

​​Line charts: Line charts give you an insight on closing prices for each period. However, it doesn't provide much information on the opening, high or low rates.

​​Bar charts: Bar charts are similar to line charts although they add opening, high and low prices on their representation. For instance, if at the end of a day the opening price is lower than the closing price, the lines on a bar chart are shaded black. Conversely, if the opening price is higher than the closing price, the lines are shaded red.

​​Candlestick charts: Candlestick charts use vertical lines to represent the price movement for a given period. Like bar charts, they use different colors to showcase the difference between the opening and closing prices (whether a stock ended higher or lower): white candlesticks indicate rising periods while red and black candlesticks indicate falling period.

​​It is essential for traders to learn how to read and interpret charts information to make better trading decisions and avoid massive losses.

​​Patterns can be reversals (a specific trend will reverse after completion of a pattern) or continuations (a trend will continue after completion of a pattern).

​​4.  Chart patterns: Chart patterns indicate the continuation of an existing trend, and it also shows possible support and resistance breakouts or reversal points.

​​Patterns can be reversals (a specific trend will reverse after completion of a pattern) or continuations (a trend will continue after completion of a pattern).

​The most known chart patterns are:
  • ​​Heads and Shoulders: This type of chart represents a reversal pattern
  • ​​Triangle: Triangles are among the most popular and reliable chart patterns. Triangles can be symmetrical (shows that a breakout might occur), ascending (announces a higher uptrend) and descending triangles (shows a breakdown may occur).
  • ​​Double tops and bottoms: A double tops and bottoms forms after a stock price breaks a resistance or support level twice without experiencing a breakthrough.
  • ​​Cup and handle: This type gets its name from its shape. It represents a continuation pattern in a bull market: the upward trend temporarily stops, but it will continue once the pattern is complete.

​​5.  ​Technical Indicators: Technical indicators are mathematical equations used to analyze historical data and decide entry or exit point in a trade. They spot the strength of a trend, and they generate signals to buy or sell by identifying patterns.

​​The most popular technical indicators are oscillators (Relative Strength Index), moving averages, MACD (Moving Average Convergence Divergence), Stochastics and more.

CONCLUSION

​​As you can see there are multiple types of charts, patterns, and technical indicators and they might seem confusing and impossible to understand but with extra lessons (books, online classes, tutorial videos), and practice will help you understand and master the art of stocks technical analysis.

dentify a technical analysis that works for you and develop your trading system; blindly following other traders may not be right for you. Technical indicators are not 100% right; thus, you still need to use your intuition and knowledge before you make a move.

​​Finally, there is a good number of technical analysis software that you can use for your trading such as MetaStock, Worden TC2000, eSignal and so on.


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