Technical Analysis Basics


What is Technical Analysis?

Technical analysis is a security analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Primarily this methodology uses stock charts as a basis to make trade decisions.

There are three assumptions about technical analysis:

  • The market reflects everything in the stock price – This is saying that all economic factors, company performance, trader’s forecast of future performance, etc..  are factored into the price of the stock.
  • Prices moves in trends – Disregarding minor price fluctuations, stock prices moves in certain directions for an appreciable period of time.
  • History tends to repeat itself – This could be due to market cycles, human psychology or natural coincidences that stocks prices tend to follow some form of pattern that repeats itself.

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Where do we start? Charts!

Alright, enough of the boring introductions. Let’s go into action.

First, you’ll need a tool to view charts. If you do now already have one, you can quickly start with a free website like Yahoo Finance.

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Trends!!!

Stocks trends are classified into three types. Uptrend, Downtrend and Sideways.

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Uptrend

Uptrend

A simple way to describe an uptrend is if the prices form higher highs (green circles) and high lows (red lines) as seen in figure 1.

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Downtrend

Downtrend

On the contrary, a downtrend is described as when the prices form lower lows (red circles) and lower highs (green lines) as seen in figure 2.

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Sideways

Figure 3 Sideways Trend

Figure 3: Sideways Trend

A sideways trend is a trading range where the price bounces up and down within a flat sideways channel. This can be seen in figure 3 where the highs and lows are bounded within the upper boundary (green line) and lower boundary (red line).

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Time Frame

A trend is relative to the time period that you are looking at. A yearly chart, monthly chart, weekly, daily, hourly chart and daily charts. For most charting softwares that are provided by your broker or paid subscriptions, you will be able to toggle your charts according to above time frames. However, if you do not have any of the above, Yahoo Finance works well, except that the time frames are slightly different.

Let’s use the free tool from Yahoo Finance to show you some real examples.

Apple up and down trendsFigure 4: Apple 5 Year Chart

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Referring to figure 4, looking at Apple’s 5 years chart, you are able to see a an uptrend from Jan 2011 till around 3rd quarter of 2012. It then turns into a downtrend which lasted till around middle of 2013. Turns around and goes into its second uptrend till end of the chart in early 2015.

You may also say that the chart went into a slight sideways trend from early 2013 till mid 2013 before it starts turning into an uptrend.

As you can see, looking at a long term chart enables you to see major trends of the stock. You will always want to start looking at the major trend to set the right direction of your trade before you move into smaller time frames to select better entries.

Lets now zoom a little deeper with a 1 year frame on the same Apple stock during 2013 and see how it looks.

Apple 2013 1 year timeframeFigure 4: Apple 5 Year Chart

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The sideways trend or channel that is not apparent suddenly becomes much more obvious in this 1 year time frame.

In this chart above, you can see mini uptrends and downtrends happening within the channel itself. Hence, in each time frame, there are always smaller trends happening in even smaller time frames.

You should have now gotten the main idea of trends and played around some charts to view the different time frames. Next step will be to understanding trend lines.

 

Read on

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