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What is Technical Analysis? Definition with Examples


Technical Analysis Definition:

Before we answer the question, let us know what an analysis called is. Basically, an analysis is a detailed examination of the elements or structure of a particular subject. But, here we will discuss the examination of securities and investment decisions that are majorly categorized into two parts: fundamental analysis and technical analysis. In simple words, “Technical Analysis can be defined as study and implementation of market data to make trading decisions”.

These market data consists of various indicators including the charts of price, volumes, averages, candlestick patterns and can help predicting short-term market trends. Technical analysis uses the past stock volume and price information, attempts to understand the market patterns and predicts the future price movements.

For example, if you are willing to buy the stocks of a drug supplier company, the technical analysis will help you study the past records of ups and downs in the prices of that company. Through the help of historical prices and their graphic representations, it will help you draw a common pattern for the ups and downs in the prices. Relying on those patterns, it will help you forecast when the prices of the stocks of that company may rise and when it may fall in future and make a decision whether you should but their stocks or not. Technical analysis employs a number of latest and advantageous tools to analyze various indicators but the main theory still revolves around the supply and demand factors.

History of Technical Analysis:

The history of technical analysis is more than four centuries old. The first graphic representations appeared in Japan during the 16th century. Their goal was to seek to cover the evolution in the rice prices by using Japanese candlesticks. If you haven’t heard the candlestick term, we will discuss it in the upcoming chapters.

Thereafter, the traditional chartist analysis developed in the United States in the 19th century through Charles DOW (now famous founder of Dow Jones, the American rating and the Wall Street Journal index). Charles DOW was the first to distinguish between recurring and repeatable trends empirically.

Modern graphical analysis appeared in the 1970s with W.WILDER. His arrival coincides with the development and the explosion of the computer tool. He introduced the mathematics and statistics at the discretion of the traditional graphics. So, the technical analysis saw the birth of indicators suggesting support for the decision-making of an analyst.

Technical Analysis Analogy:

Let us understand the analogy of technical analysis through an example. Suppose a new carnival has come into your city and you decide to visit it once, to spend your leisure. After buying the thinks you liked and eating your favorite dishes, you stand in a corner where the tickets for live performance shows are sold. You are tired now and want to relax your body and mind by watching some interesting acts. What you are likely to do is giving a try to a performance show and relax yourself.

But the problem starts now. There are a number of live performance shows being showed and the problem is about choosing the show you would like to watch. You have no idea about which show will be entertaining and which one may bore you.  In addition, you cannot ask the people in the carnival as the carnival has started today only and no one has watched all the performances.

What all you can do is going for one of these two options:

Option 1: The first option is that you can visit the counter of a show and try to find out what they are showing. You may also ask the salesmen about the content of the show, genre of the show and duration of the show. You may also query the name of the artists performing in the show. You can repeat this query at multiple counters and may collect an idea about the same. Chances are that you may end up watching an entertaining and mind-soothing show.

Pros & Cons: This method has an advantage that you will know what exactly you are going to watch as you only have researched everything and made a decision thereafter. However, the disadvantage of this method is that it’s not much scalable as you cannot visit each and every counter and chances are that you may miss the best show at the carnival.

Option 2: The second option is that you can stand aside and notice all the people going to the shows. You can find there are some shows that attract fewer audiences while some of them attract a huge crowd. You can figure out a show that is attracting the maximum audiences. The show attracting the maximum audiences may be assumed to be the most entertaining. Relying on the preference of crowd, you may decide to watch that show and chances are that you get to watch the best show in the carnival.

Pros & Cons: The scalability is the main advantage of this option. You just have to figure out the show with maximum and bet for the same. The disadvantage of this method is that the decisions of majority can’t always be right.

If you have read the fundamental analysis, you will find the option 1 similar to that, where a detailed study is done for a particular company. If not, we will discuss the fundamental analysis in upcoming chapters.

While the option 2 is more like technical analysis and the current and past behaviors of the market are thoroughly studied to seek out the trading opportunities. In next chapter, we will discuss how to look at a chart and get exactly what a chart says.

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