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Technical analysis

By: Mohit Mehra 97-MBA-10

Technical analysis
Technical analysis is a financial term used to denote a security analysis discipline for forecasting the direction of prices through the study of past market data, primarily price and volume.

The correct definition of technical analysis is "the skill of being able to predict a particular security in the financial market". This type of analysis revolves around the actual movement of the market; this is not the case with fundamental analysis. Factors related to politics or economics are pushed aside, though they do have an impact on a market's movement. It searches for patterns or trends that can recur in the future. When this knowledge becomes available, prediction of what will happen in the future becomes easy.

Despite this analysis being quite reliable, it is advisable to go in for fundamental analysis also. A comparison between the results of both will give a double edge to accuracy.

Technical analysis employs models and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions. Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the facts of the company, market, currency or commodity.

How is fundamental analysis different?

If a fundamental analysis is to be done about a particular company, it includes factors like--how money is being managed by the company, how its performance has been in the past and how stable the current government is regarding trading currency. Thus, this analysis probes the reasons for the market's movement. Technical analysis is only bothered with how the market is actually going to move. The company's present or past performance, how it takes care of its money--all these are irrelevant!

Technical analysis is based on three assumptions

Basic principles of technical analysis. 1. The market discounts everything. 2. Price moves in trends. 3. History tends to repeat itself.

The Market Discounts Everything

Dow believed that the market discounts everything, and in the information age where news is instantaneous, that belief is solidified even more so in today's world. Technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company. This includes the company's fundamentals, economic factors, market psychology, current earnings, potential growth, inventories, sales; all known and unknown factors are priced into the stock. This only leaves the analysis of price movement, which is a product of the supply and demand for a particular stock in the market.

Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend until the major trend changes and a new trend is established. Historically, this has been the case. Just as Dow believed more than 100 years ago, this belief continues to hold true.

History Tends To Repeat Itself

Another important factor in technical analysis is that history tends to repeat itself, especially in terms of price movement for the overall market and with individual stocks as well. The repetitive nature of price movements can be attributed to market psychology and even the underlying intrinsic value of a company. Technical analysis uses chart patterns to analyze overall market movements and price history, understand the trends, and allow the investor to more accurately determine the possible future direction of not only an individual stock, but also the overall market as well. Charts have been used for more than 100 years, and are still believed to be relevant because they illustrate patterns in price movements that consistently repeat themselves.