What is Technical Analysis in Stock Trading?

Math, stats, and market data. You’d think many would switch off when these three are involved. Yet, the opposite is true. Technical analysis is a massive part of the stock market and is practiced by millions of investors and traders worldwide. Some claim that technical analysis is the best way to trade financial assets as it gives you a perfect visualization of the market’s supply and demand. 

Want to know more? Let’s hit the basics.

What Is Technical Analysis?

Technical analysis, also known as TA, is the study of historical price action to identify price patterns and probabilities of future stock price movements in financial markets by studying price action through common technical indicators and chart patterns.

Someone who uses technical analysis is called a technical analyst and investors who use technical analysis are known as technical investors. Technical investors pretty much live, eat, and breathe stock charts to identify the trend, support and resistance levels, which could help them find some opportunities to invest. More than anything else, technical analysts rely on price patterns and technical indicators. 

They see the markets as chaotic and dynamic but believe that price actions are not completely random. In fact, technical traders believe that within this state of chaos, there are identifiable patterns that tend to repeat. Therefore, they analyze the stock’s historical data and past performance, and based on this data, they try to predict the future stock price movement. 

Sounds complicated? Here is a simpler definition. One day the share price data is going up; another day, it might be going down. But over time, if you look at the stock’s price movement, you will likely see trends and various chart patterns emerge. Know the saying that history tends to repeat itself? Well, that’s basically what all technical analysts want to be put on their tombstones.

Okay, not really, but you get the point. 

Key Principles of Technical Analysis

There are three basic principles of the technical analysis methodology. Those include:

1. Market’s Price Discounts Everything

The first technical analysis principle says that the price action on trading charts discounts everything, meaning all the relevant information, including news and economic data, is already factored into the current stock price. With that, technical analysts believe that price and volume data tell us everything we need to analyze the stock. To some degree, this principle rules many elements of fundamental analysis. Unlike fundamental analysts, technical analysts believe that market price reflects all the relevant information that can be found on a price chart. 

2. Prices Move in Trends

Another technical analysis principle states that stock prices tend to move trends – upward, downward, and sideways stock trends. Typically, technical analysis traders use past price movements, chart patterns, and technical analysis indicators to determine the strength and direction of a trend. According to this principle, markets react to the herd behavior phenomenon where people act collectively and take the same actions as others. 

3. History Repeats Itself – Technical Analysts Believe that Price Movements Follow Established Patterns 

This is a very important technical analysis principle. That’s why technical traders spend a big part of their day looking for similar chart patterns formed in the past and developing trade ideas believing that price could possibly act the same way it did before.

According to technical analysis theory, market prices move in waves and have repetitive patterns. This means that if you learn to identify chart patterns and specific price movements, you can find successful trades and eventually become a profitable trader using technical analysis tools.

For example, one of the key tools to predict future price movements is by using support and resistance levels. Based on this tool, the stock price can make the same movement it did before, hitting the support or resistance level several times before breaking these levels.  

Summary

To sum up, technical analysis of stocks is not so much about prediction but rather probability. This means that successful trading using technical analysis is NOT about being right or wrong. Instead, it is about determining probabilities and taking trades when the odds are in your favor. For that matter, many analysts and traders believe the ideal approach is to combine fundamental and technical analysis.

Regardless, if you learn how to master technical analysis in stock trading, you’ll be able to find many trading opportunities by finding repetitive chart patterns and getting the right signals using technical analysis indicators. It is not as simple as it sounds but not so complicated as well.

But more on that and charts, trends, patterns, moving averages, and other aspects of technical analysis in later chapters.