The two common methods that are used to analyse stocks in the market that will help you to make sound investment decisions are fundamental analysis and technical analysis. Whereas in the former an analysis of the company’s characteristics is done so as to evaluate the value of its stock, technical analysis involves only the price movements of the stock in the market. It does take into consideration any value of the company concerned.
Technical analysis is simply a method of finding out whether it worth buying or selling a stock. This study can be made on the basis of data that is generated through the actions of the people in the market. Technical analysis attempts to measure the collective psyche of the investors which is ruled by greed and fear.
The basic premise under which technical analysis works is the study of demand and supply, past prices and volume in the market and the direction of the price trend thereof in the future. Investors that favor technical analysis make use of a number of charts and other tools that help to chart the future activity in the investment market by identifying patterns. Knowledge of technical analysis is a skill that any investor can use to make better investments in the stock market.
There exist different types of technical traders in the market. Whereas some depend on patterns that are generated by charts, others depend on oscillators and indicators. There are yet others that make use of both. However, the most important fact is that they use historical price and volume data. Whether a stock is undervalued does not concern the technical traders. Technical analysis relies on three basic assumptions:
- Price movements occurs in trends
- History repeats itself in the markets
- The market discounts everything
Technical analysis can just about be used for any security that has historical price data: forex, commodities, futures, stocks, etc.
Importance of Technical Analysis When Trading Stocks
The most common question that an individual asks a trader is what stock to buy. Most people want an investment that they can buy and hold. As it is most people are busy with their own lives and one cannot expect them to bail out when there are signals (such as high-volume reversals) from the stock market. What a common investor expects is a long-term investment plan with a diverse portfolio coupled with an advancing stock market.
However, there are traders that make a good amount of profit in the short term even in times when the market stagnates. Short-term traders have to make their decisions quickly, be correct only for a limited period of time, and move to the next trade as quickly as possible. In most such cases, the selections are made as a result of technical analysis. There are several reasons for this decision.
A majority of short-term trades occur because of variations in supply and demand. Technical analysis rests on the premise of these two factors and not on the fundamental characteristics of a company. To decide whether one should stay with a stock or get out chart patterns are of great help. The trends presented by the charts help to take notice of the resistance, support and momentum that help the trader to take a decision. Knowledge about those points where buyers and sellers lie in wait to make money and exhibit related emotions can be got through technical analysis.
Technical analysis gives rise to situations wherein being right for a small amount of time can result in big-time rewards for the traders. The trader can work with an extra amount of confidence if they zero in on chart patterns with stop-loss positions that lie close enough.
For many traders trading with only fundamental analysis puts them at a disadvantage. Research into a company based on information from a financial website does not give it all for a trader. Whatever the existing figures say, what the next quarter performance can be for a company may not be easy to predict. However, when one is in touch with the management of a company, the figures that arise are more concrete.
Short term technical trades means that the trader is in and out of the market more frequently. This also helps a seasoned trader to compound money at a faster rate. Five consecutive trades that bring in 2 percent on the money invested makes more sense than making a single investment that brings in 10 percent gain. Fundamentals of a company takes months or years to play out and hitting small gains in the meantime using technical is definitely worth it according to the short term traders. It is not easy to spot out a company and predict that it is going to a Microsoft in the future using fundamentals.
Another point that is true is that all good companies’ stocks always do not go up. It makes more sense to make a profit when the money invested is at risk. As the short term traders put it, it makes more money sense to buy a stock that is moving up however good or not the company may be. If there is no demand for the stock of a company, then one can be sure that its stock is not going to move up. One cannot wait for a good company to be discovered to make money on its stock.
A short-term trader that uses technical places the capital on risk only in the presence of opportunities but otherwise preserve it. Trading stocks on the basis of technical analysis allows the trader to maximize profits while simultaneously limiting risks by following solid plan of action.