Some think that technical analysis is hocus-pocus but the reality is it’s nothing like that at all. Good technical analysis is the art of recognizing patterns as they relate to price. For years, fundamental analysts have mocked technical analysts, regarding them as little better than palm readers.
Nobody doubts that fundamental events, such as earnings reports and news of corporate wrongdoing, can and will move stocks. The fact is that there are also plenty of stocks that do not move based on the strength or weakness of the company’s balance sheet.
Technical analysts use a chart to measure the weakness or strength of a stock. The price is the market’s “scoreboard” on a stock and technical analysis is all about price and is the reflection of everything that is known and what people perceive about a stock at any given time. So the chart used to evaluate stocks is a bit like an x-ray, looking into the bones of that stock.
When evaluating a stock, a technical analyst begins with the obvious resistance and support levels. These are the price levels where the stock gets stuck, refusing to drop further than the low point or unable to rise above the high point.
Double bottoms and double tops.
Two of the common chart patterns are known as “double bottoms and “double tops”.
A double top describes a pattern where the price of a stock reaches a peak, falls and then goes on to regain the original peak further in the future. You’ll most often find that a sock that hits a previously held peak will sell off. Why does this happen? Experienced technical analysts would say that the traders who bought at the first peak anticipating that the stock would continue to rise were disappointed when it fell. Those investors hold on until the stock returns to its previous levels and once that happens, they are relieved and sell the stock, which makes it fall all over again.
The psychology of the stock market as a whole plays a big role in technical analysis. After all, for the most part, trades are made by human beings (although trading run on programs is becoming more common) and there is no way to completely separate human emotion from finance.
Bollinger bands are another metric that gives a good indication of the psychology involved in technical analysis and the market. These bands contain 95% of the price action of the stock.
Another metric that is an indication of psychology of the market that is represented by technical analysis is the Bollinger Bands. These bands contain 95% of the price action of the stock. When a stock starts trading outside of the band, what typically happens is it begins to stall and trade sideways or retraces to return inside the band. Technical traders are acutely aware that when a stock starts moving too rapidly, it will soon begin to work its way back inside the bands (or revert back to the mean).
One of the most important but also most over-looked and under-utilized tools in technical analysis is volume. At certain levels, when price action occurs technical analysts can decide if the move is credible or not by looking at the participation of the investment community.
A high volume move has a lot more credibility than low volume moves. For example, a stock that is breaking above a key resistant point on higher than average volume will have more credibility.
Popular business shows, such as those on CNBC are beginning to incorporate technical analysis into their commentary, which provides evidence that this form of analysis is growing in popularity.
Traders don’t have to choose between following fundamental or technical analysis; the two are in no way mutually exclusive. To be a consistently successful trader in the market, it’s wise to embrace both disciplines.
At MarketTamer.com we can open up a new world of technical analysis to keep you ahead of the game. Come join a proven winning team today at www.markettamer.com.
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