Principles of Technical Analysis: Technical analysis is a method used to analyze the movement of stock prices and find trading opportunities by studying charts and statistical trends like price action and volume.

What Is Technical Analysis Exactly?

Technical analysis was a technique created by Charles Dow, co-founder of the Wall Street Journal and the Dow Jones Industrial Average, who used price and volume data to predict the price of different securities.

There are three main principles of technical analysis based on the six tenets developed by Charles Dow in his Dow Theory.

Here, Price refers to the value of a single stock, while volume refers to the number of stocks traded in a particular time frame.

In technical analysis, different types of price charts are used, which determine price, volume, and signals whether to go buy or sell.

How Is Technical Analysis Used?

Technical analysis is a technique used to predict the price movements of stocks, bonds, futures, and currency pairs.

There are many patterns that are developed by experts and used wildly by traders around the world so many patterns affect the price of stocks.

Technical analysis helps traders to decide when to go long or short based on the supply and demand of the stock, which can also affect the movement of the price of a stock.

Technical analysis is a study of past behavior of price movements to determine and predict the future of a stock. How stock prices moved in the past, based on that study traders can make further decisions.

Principles of Technical Analysis

There are mainly three basic principles of technical analysis.

1. Market discounts everything.

2. Market movement is dictated by trends.

3. Market moves in waves and historical information is important.

Market Discount Everything

The first and most important principle of technical analysis is that the market discounts everything and the value of a stock is reflected in the price of a stock

Here,

Everything includes news, facts, data, emotions, and expectations In the context of the market. and Everyone (including the fundamental analyst) considers each small piece of information to make only one decision: either go to buy or to sell. This decision directly affects price and volume.

And everyone is interested in the price. The price itself says if we are in the bull or bear. As market prices fluctuate, your portfolio value also fluctuates. This is why the market is important.

The change in this stock value affects its price and the market responds to it. News, facts, and data are all used for one singular purpose, which is to decide whether to go long or short.

This one single decision is directly proportional to changes in both price and volume. The price is the most important factor and what technical analysis focuses on most. The price itself tells us whether the market is green or red.

Fluctuation in market price affects the change in net asset value. All this is to say, the market discounts everything and is the most important principle of technical analysis.

Don’t Miss: Elliott Wave Theory

Market movement is dictated by trends

The second principle of technical analysis is that prices are determined by trends, which will continue to move in the same direction unless some reversal pattern occurs or an indicator suggests a reversal.

The basic concept is that the trend needs to be followed for an inch-perfect analysis. As an example, say the price has been rising consistently, but a candlestick pattern confirms that it will start to fall. In this case, a trader would follow signals and may decide to go short for that particular security.

Stock Price is a rising point to a trend that will likely move up or, if the market is falling, will continue to go down. On the other hand, if the market is consolidated, it will react that way.

This is also the main reason why the trend is very important in technical analysis, and following the trend is important for correct analysis of the market to get the best results.

The market moves in waves and historical data is important

The third principle of technical analysis is that historical patterns and trends are extremely important to determine the current price movement of stock.

Technical analysis believes that patterns that have occurred in the past tend to repeat themselves in the future.

The market moves to make highs and lows and, as information on stocks keeps fluctuating, the market has a moving goal. Furthermore, a technical analysis depends on market psychology to explain patterns in price charts.

While the market has an unknown target price based on fundamentals, changing information swaps the market moving target. The price does not always move in a straight line to reach the target price. It will be moved in a zig-zag pattern.

Market psychology refers to the communal sentiment of investors and traders in the market, and focusing on this psychology is important to accurately determine fluctuation in stock prices.

Technical analysis gives importance to the sentiment and behavior of traders and investors.

For example, if investors are positive about a stock, they may buy the stock. This will result in the price going up. On the other hand, if traders find that stock is overbought, they will sell the stock and prices will fall.

Also Learn: Price Action Trading Guide

Traders are analyzing in different time frames and have different goals. The result of this is that resistance could exceed support at one moment and support could overcome resistance at the next moment. The variance in results changes in prices and it causes the price to move in waves.

Technical analysis places special significance on these changing waves, which help to determine the most potential max/min prices of a stock and for increasing the accuracy of analysis during trading.

Always keep in mind that while technical analysis can be extremely helpful, it is only meant to provide a signal and never to be taken as a confirmation.

Author

Prashant Raut is a successful professional stock market trader. He is an expert in understanding and analyzing technical charts. With his 8 years of experience and expertise, he delivers webinars on stock market concepts. He also bags the ‘Golden Book of World Record’ for having the highest number of people attending his webinar on share trading.