Question

Explain what technical analysis is and how you can use it to make an investment decision. Please provide examples to illustrate your points and any website visited.

Answer 1

Investors deploy 2 major techniques to evaluate stocks before making a trade or long-term investment decision which are be divided into fundamental analysis and technical analysis.

What is technical analysis?

- It is a short term approach of investing.

- It analyzes charts, past stock pricing and volume data, and examines historical data to find patterns in an attempt to predict future trends

- Indicators considered are - price movements and trading volume metrics, a business’s strength relative to its peers in the same sector/overall market, and other similar indices.

- It is based on 3 rules as under -

a. Stock price is the true reflection of status quo (i.e what has happened & what might happen to a company)

b. Stock prices dont move random they follow certain trends.

c. History repeats in stock market provided given enough time due to market psychology. Investors are in their reactions.

- Technical analysis attempts to forecast the price movement of virtually any tradable instrument that is generally subject to forces of supply and demand, including stocks, bonds, futures and currency pairs. In fact, some view technical analysis as simply the study of supply and demand forces as reflected in the market price movements of a security.

- When analyzing the stock charts, you can create price charts that help determine your next move. With the help of technical analysis, you are able to identify the following factors:

a. Instability in the stock prices in the past and present.

b. Stock’s ability and value compared to the overall market

c. Price fluctuations and stock value before and after important events.

d. History of volume and trading levels.

- By performing pricing technical analysis, one is able to determine support and resistance levels. These levels define the periods of congestion in a stock chart where the prices of stocks fluctuate within a limited band for a long range of time.

When you are able to identify support and resistance levels, you can make better decisions whether to invest in a particular stock or not. When prices break the barrier, it means that the supply and demand are in a good state.

- Helps Time Entry Points - Another benefit of stock chart technical analysis is that it helps investors’ time entry points. With the help of technical analysis, you know exactly when to time your action. Investors are also able to understand demand and supply levels, and breakouts to make better decisions. Buying close to support levels or a breakout above resistance helps you earn greater returns on your investment.