Technical analysis is the art of pattern recognition as it relates to price. Some think it is hocus-pocus but in reality it is anything but that. Fundamental analysts have poked fun at technical analysts for years regarding them as nothing more than tarot card readers. It is true that fundamental events, such as earnings reports and corporate malfeasance can move stocks. However, there are plenty of stocks that do not move based upon the strength of the company's balance sheet.
Technical analysis is all about price and is the reflection of all that is known and perceived about a stock at any particular time. The price is the markets 'scoreboard' on a stock. A chart is the tool used by technical analysts to measure the strength or weakness of a stock. The chart is in essence an x-ray into that stock. When a technical analyst evaluates a stock, it begins with obvious resistance and support levels. These are price levels that have shown to be areas, where the stock stubbornly refuses to drop further or in turn has difficulty ascending above a higher price point.
Some common chart patterns are 'double bottoms' and 'double tops'. A double top is where the price of a stock peaks and then subsequently drops to only regain the original peak at some point in the future. More often than not, a stock that hits a previous peak will sell off. Why? Practitioners of technical analysis will tell you that the traders that bought at the first peak in anticipation of the stock running higher were disappointed at its fall. Those investors are holding onto until the stock regains its previous levels once again and when it happens they are relieved and sell the stock, which in turns causes, the stock to drop.
Technical analysis has much to do with the psychology of the overall stock market. Trading is conducted, for the most part, by human beings (programmed trading is becoming more prevalent); and as such human emotion is involved.
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 the stock trades outside of the bands it usually begins to stall and trade sideways or retraces to return inside the Bollinger bands. Technical traders are aware of this fact and when a stock moves too far too quickly, it begins to revert back to the mean (inside the bands).
Volume is one of the most important but most frequently overlooked an under-utilized tools in technical analysis. When price action occurs at certain levels, practitioners of technical analysis can ascertain whether the move has credibility or not based upon the participation of the investment community. A low volume move has much less credibility than a high volume move. For example, if a stock was breaking above a key resistance point on above average volume, more credibility will be given to such a break out.
Technical analysis is growing in popularity. One only needs to witness the recent incorporation of technical analysis on the popular business shows, such as those on CNBC to see evidence.
It is not mutually exclusive that a trader either solely follows fundamental or technical analysis. Both disciplines should be embraced in order to be a consistently successful trader in the markets. 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.