Logic behind technical analysis
Selecting the right stocks for investment is an important part of making investment at the stock market but that is not the only thing that you have to consider. More important than the selection of stocks is determining the perfect time for investing is that stocks. Stocks have price movement at the stock market everyday. There are ups and downs that come in a cyclic way. As an investor you have to determine what is the exact time or more precisely the optimum price range for investing in that stock.
The reason behind this is that every stock has a potential price for a given time. It takes certain time to reach that point and once the stock reaches that price, it is most likely to fall or stand still at that level with least movement in the price. In both the scenario it is not profitable to invest in stock that has already reached that optimum level, as you will either make loss or get least profit. Therefore, it is not worth investing in the stocks that are already reached the potential high for the time being. So as a trader it is important to know what is the optimum price range for the stock as that will help you to decide whether it is the right time to invest in a certain stock or not.
Technical analysis is the process that does exactly that. Technical analysis can give you the idea of the future price movement of that stock. Based on that analysis you can decide whether it is profitable in that stock at that point. In technical analysis certain information like the past performance of the stock, current price of the stock, trading volume of the stock are considered. With these information and one the basis of certain principles different types of graphs and charts are prepared. By comparing these graphs of the price movements with that of the previous years it is decided by the experts how the stock will perform in the near future. So, basically technical analysis is the scientific way of predicting the movement of the stock price in the market. Technical analysis is performed by the analysts on the basis of different indicators such as cycles regressions, relative strength index, moving averages, regressions, and inter-market and intra-market price correlations. Different principles are followed by the analysts to prepare the charts and graphs of the price movements of the stocks on the basis of these indicators. These indicators are basically mathematically transformed date derived from the price of the stocks and trading volume. Here we are presenting some of the most popular models of technical analysis.
Candle Stick Charting – This method was developed by Homma Munehisa during 18th century. In candle chart method the price movement of a certain stock is predicted through the bar style chart. This chart is basically a combination of the simple line chart and colored bar chart. The candle stick chart gives a graphical presentation of the opening price, closing price, high and low price of the stock in a single day for over a period of time. This graphical presentation helps to predict the future movements by comparing the previous patterns of price movement of that stock.
Dow Theory – This theory is named after its inventor Charles H. Dow. He was the first editor of the Wall Street Journal and co-founder of Dow Jones and Company. The Dow Theory is based on six basic principles.
* There can be three different types of movements in the stock market.
* There are three different phases in the market trends.
* Stock market discounts all news.
* Market trends need to be confirmed by trading volume.
* Market average should always confirm each other.
* Market trend can be said have ended only when the definitive signals prove that.
Elliott wave principle - This theory was developed by Ralph Nelson Elliott and published for the first time in his book The Wave Principle in the year 1938. In his theory Elliott proclaimed that the psyche of the stock market investors moves from pessimism to optimism and this creates the swing creates the price pattern. This pattern is projected by the three wave structure of increasing degree in this theory.
In addition, it is important to know that two basic tenets of technical analysis are that prices trend and that history repeats itself. An uptrend indicates that demand is in control, and a downtrend, that supply is in control. As the balance shifts, a pattern emerges. The majority of patterns fall into two main groups: reversal and continuation. Reversal patterns indicate a change of trend. Continuation patterns indicate a pause in trend, suggesting that the previous direction will resume later. However, just because a pattern forms after a significant advance or decline does not mean necessarily that it is a reversal pattern. Much depends on previous price actions, volume and more as the pattern evolves. This is where technical analysis becomes an art.
