Technical analysis: Understanding Market Trends

What is Technical Analysis?

Technical analysis is a method used by traders and investors to evaluate stocks and predict future price movements based on historical price patterns and trading volume. Unlike fundamental analysis, which focuses on a company's financial health, technical analysis relies on charts, trends, and indicators to make trading decisions.

Key Principles of Technical Analysis

1. Market Discounts Everything -
   Technical analysis assumes that all relevant information, including economic factors and company fundamentals, is already reflected in the stock price.

2. Price Moves in Trends -
   Stock prices follow identifiable trends (uptrend, downtrend, or sideways movement), and traders analyse these trends to make informed decisions.

3. History Repeats Itself -
   Market behaviour follows historical patterns, as investor psychology remains consistent over time.

Essential Technical Indicators

1. Moving Averages (MA) -

   • Simple Moving Average (SMA) – Calculates the average price over a specific period.

   • Exponential Moving Average (EMA) – Gives more weight to recent prices, making it more responsive to changes.

2. Relative Strength Index (RSI)

   • Measures the speed and change of price movements.

   • RSI above 70 indicates overbought conditions; below 30 suggests oversold conditions.

3. Moving Average Convergence Divergence (MACD)

   • A trend-following momentum indicator that shows the relationship between two moving averages.

   • A bullish crossover occurs when the MACD line crosses above the signal line, while a bearish crossover happens when it moves below.

4. Bollinger Bands

   • Consist of a middle moving average and two standard deviation lines.

   • Prices near the upper band indicate overbought conditions, while prices near the lower band suggest oversold conditions.

5. Support and Resistance Levels

   • Support – A price level where demand is strong enough to prevent the stock from falling further.

   • Resistance – A price level where selling pressure prevents the stock from rising higher.

Common Chart Patterns

1. Head and Shoulders

   • A reversal pattern signalling a change in trend direction.

   • A head and shoulders top indicates a bearish reversal, while a head and shoulders bottom suggests a bullish reversal.

2. Double Top and Double Bottom

   • A double top signals a bearish reversal, while a double bottom suggests a bullish reversal.

3. Triangles (Ascending, Descending, Symmetrical)

   • These patterns indicate a continuation or breakout in price direction.

Technical Analysis vs. Fundamental Analysis

Summary

Technical analysis is a powerful tool for traders looking to capitalize on price trends and market patterns. By mastering indicators, chart patterns, and support/resistance levels, investors can make informed decisions and enhance their trading strategies. However, it is essential to combine technical analysis with risk management techniques to maximize success.