What isTechnical Analysis?
Before investing in the financialmarkets , you must determine how you will find the best investment
opportunities. Stock Technical Analysis In Australia and fundamental analysis are the two mostpopular types of market analysis. Let's see how technical or chart
analysis works and what are its limitations.
Technicalanalysis – definition
In trading , technical analysisis a method used to identify trading opportunities based on stock price action,
trading volume, and other statistical and mathematical information.
Technical analysis – which works on alltypes of assets such as Forex , stocks ,
indices, commodities and more – allows:
to identify significant price levels;
to detect chart patterns supposedto show signs of trend reversal, indecision or continuation of the current
trend;
take advantage of relevant trading signalsin the short term.
3 examples of technical analysis
Support andResistance
A support materializes a level concentrating a strong demand causing
the pause of a bearish movement or the reversal of a bearish
trend . Upon contact, prices rebound temporarily or
permanently. If the price breaks a support, then the bearish movement
accelerates towards the next level of support.
Trend Line
For technical analysts, prices alwaysmove in a trend . It can be bullish, bearish or neutral. A trend
line is therefore a line that links a series of prices to highlight the
direction that a given asset is taking .
An ascending trendline characterizes an uptrend and follows higher and higher
highs and lows. In this case, prices will be above the trend
line.
A descending trendline representsa downtrend with lower and lower highs and lows. In this case,
the prices will be below the trend line.
Overbought andoversold situation
There are many technical mathematicalindicators to rely on in technical analysis. Some make it possible to
highlight overbought or oversold situations such as the relative
strength indicator (RSI technical indicator ) or the Money Flow
Index (MFI) .
These extreme price situationsrepresent areas in which the price tends to turn around : downward in
the case of an overbought zone or upward in the case of an oversold
zone. This makes it possible to identify opportunities when the
buying or selling pressure is too great on an asset.
Limitationsand criticisms of technical analysis
There are 3 main principles on whichtechnical analysis is based:
prices reflect all information available atany given time
assets are always trending
The story repeats itself
Technical analysts therefore consider thatonly the study of price movements and the use of technical indicators are
necessary to know when to enter and exit the market. Prices indeed give
you all the necessary information about investor sentiment and potential future
price movements. However, there are certain criticisms and limitations
regarding the principles that govern technical analysis.
First, many critics of technical analysisare unconvinced by Fama's market efficiency hypothesis. To consider that
all available and relevant information regarding the forces that govern the
supply and demand of an asset is instantly factored into the price would be a
flawed process of analysis. Thus, taking into account the evolution of
stock market prices by thinking that they integrate all the information
available to predict the direction that an asset will take would not work.
Finally, some believe that technicalanalysis works primarily because it is a self-fulfilling prophecy. This
concept refers to the fact that a market movement will only occur because it is
anticipated by a large number of traders who place orders at a certain price
level. Since the behavior of market participants is impacted by this
anticipation, the consequence is that this event occurs.
TechnicalAnalysis vs Fundamental Analysis
Two camps compete when it comes todetermining the best way to analyze the markets to take advantage of the
opportunities that arise. This is technical analysis vs. fundamental
analysis.
While technical analysis is based on thechartist study of an asset's prices, fundamental analysis does not at all
consider the evolution of an asset's prices. Rather, it will take into
account fundamental factors concerning the asset in question. The idea is
to be able to determine its intrinsic value to know if it is currently
overvalued or undervalued by the market and take advantage of it.
If you are a fundamental analyst and youinvest in S&P 500 stocks , for example, you will focus on
financial data and ratios that will analyze:
the performance of thecompany per se or compared to its peers (sales, profits,
turnover, margin, etc.)
its growth prospects
their level of indebtedness
its dividend
its development projects
the return on its shares
Beyond information about the companyitself, you should also consider data related to the following:
the sector of activity in which it operates
the state of the economy as a whole
the evolution of exchange rates if thecompany is present in several markets
the competitors
commodity price changes
changes in regulatory, tax, monetary andfiscal policies
