Basics of Technical Analysis

We are all Technical Analyst. You would say, “How is that possible? I don’t know much about it; how can I be a Technical Analyst?” …Well, hold your horses. Let me tell you how. Let’s assume there’s an Avengers movie releasing on the upcoming Friday. You are excited and can’t wait to watch it. Sadly, you realize you only have around Rs. 400 left from your pocket money. You find the movie ticket cost to be around Rs 500-600. Why? Because the demand for this movie is high. So, you decide to watch a morning show in the following week instead of the weekend show. Why? Because your experience in movie theatres tells you that the demand is usually low in the second week for weekday morning shows. So, it’s a win-win. You get to watch the movie and it won’t burn a hole in your pocket!
That analysis right there, my friends, is nothing but Technical Analysis. Just replace the Avengers movie in our example with stock and you have performed this basic level of Technical Analysis. However, that’s not enough when it comes to the stock market. So, let’s unfold this topic slow and steady as you read ahead.

What is Technical Analysis?

Technical Analysis is a process of predicting the future price movement of a financial instrument (stocks, currencies, indices, futures, etc.) based on its past price movements and patterns. Charts are the key tool used to analyze trends, patterns, and market sentiment of a financial instrument. This analysis can be performed for varied time frames, be it for a few minutes, daily, weekly, monthly, and/or yearly. Technical Analysts use several indicators which are statistical tools, helping them to make reliable predictions and profitable trades.

Technical Analysis vs Fundamental Analysis

You must understand that both approaches fulfil separate criteria and investment objectives. A trader should know Fundamental Analysis because to make good trades he needs some level of volatility and trade volume in the stock which is present in fundamentally good stocks. An investor should know Technical Analysis to take better entry & exit decisions.

Assumptions of Technical Analysis

1.Market Discounts everything
Technical Analysts assume that all the fundamental factors, economic factors, and market forces that can affect a stock’s price has already been discounted from the current market price of that stock. Hence, technical analysis focuses on the price movement of the stock

2.Price move in Trends
Technical Analysts assume that the stock price does not move randomly, rather it moves in a trend. A stock price can move in 3 types of trends- Uptrend, Downtrend, or Sideways trend. Once a trend is established the stock price will follow it until a new trend is established. Hence, goes the saying, “Trend is your friend until it bends”

3.History repeats itself
One of the important assumptions of Technical Analysis is that “History repeats itself”. This is because price tends to move in trends and market psychology reacts to it in a similar fashion. Hence, technical analysts study past price movements to predict future price movements.

Types of Charts

1.Line Charts
Line Chart connects the Closing price of a stock over a period of time. This chart helps traders to identify the trend in the price movement of a stock. However, this chart does not represent daily price movements like opening price, days’ high, and low. Below is the daily line chart for Nifty 50.
2.Bar Charts

A bar chart is another basic tool of technical analysis. This chart is also known as OHLC Chart i.e. Open-High-Low-Close Chart. Unlike line charts, bar charts provide us with the opening price (left extension of the bar), closing price (right extension of the bar), days’ high (top of the bar), and days’ low (bottom of the bar) of that time frame. With the Bar chart, we also understand the market sentiments (bullish or bearish) by looking at the colour of the bar. A green bar has a closing price higher than the opening price implying bullish sentiment. A red bar has a closing price lower than the opening price implying bearish sentiment. This chart also reflects volatility in a stock. A higher length of the bar means higher volatility in the stock. Below is the daily Bar chart for Nifty 50.
3.Candlestick Charts

Candlestick charts are widely used around the world by technical analysts. It provides the same price information as bar charts. If the closing price is higher than the opening price, the candle will be green indicating bullish sentiment. If the closing price is lower than the opening price, the candle will be red indicating bearish sentiment. The upper wick conveys high for a time frame whereas the lower wick conveys low for the same time frame. Below is the daily candlestick chart for Nifty 50.

Support & Resistance

Support is the price level at which the stock has bounced back up several times. There’s a high buying pressure for the stock as the prices are falling & everyone wants to buy the stock at a lower price. Therefore, demand at this level is so strong that in many cases the market prevents the price from falling any further. If the stock price breaches the support level then it indicates bearish sentiments in the market. A support line is established when there are at least 2 touchpoints. More number of touchpoints indicates the strength of the support level.

Resistance is the price level at which the stock price has bounced down several times. This happens because rising prices lead to high selling pressure due to profit booking in the markets. There is an increase in the supply of the stock which induces the turnaround in the stock price. If the stock price breaches the resistance line then it indicates bullish sentiments in the market. A resistance line is established when there are at least 2 touchpoints. More number of touchpoints indicates the strength of the resistance level. Below is the Nifty bank daily chart with its support & resistance level.

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