Technical analysis (TA) is the study
of historical price and volume behavior to arrive at better investing & trading decisions. It roots from the fact that
short-price movement in the stock market is driven by the emotions and beliefs
that influence the decisions of the buyers and sellers. One of its main aspects is the study of charts and the patterns that form within them
in order to have a stronger gauge of future price movement.
(This is the chart of the Philippine
Stock Exchange Index, which represents the performance of the top 30 companies in our stock market.
It is used to gauge investor sentiment
on our country.)
By looking at the historical movement of
the stock we are able to assess the current state of its supply and demand.
Once we have a better understanding of supply and demand we can make more
profitable decisions in the stock market.
The Three Underlying Assumptions of
1. The market discounts everything.
This is one of the strong assumptions of TA. It assumes that at any given
time all available information—such as news,
fundamental information, political events, global happenings, etc.—will reflect on a stock’s price as
these information are constantly assessed and acted upon by the market
When an information is made available to the public, or to a number of
participants, we expect that they would react
on the information. Market participants will buy and sell based on the information available to them. The
constant reaction to information will then reflect on the stock’s price or in
other words, the news or information is “priced-in” already.
Here’s an example.
In this scenario the PSEi fell from
the highs of 7900 up to a low of 6700, due to the news that the FED (US Central Bank) will increase the
interest rates—which has a generally negative effect in stocks.
Since the market was already anticipating the rate hike to happen, they already
acted on the information months before the actual date of the announcement of
the rate hike. And when the announcement itself came in, the supposedly bad
news was already “priced in”.
(The term ‘priced in’ just means that almost everyone is already expecting a
certain event or piece of information, which is why most of the market
participants would have already acted on this certain event or information.)
Often times, when the piece of information is already so obvious, stock prices tend to move oppositely from
what everyone is expecting. Those who were concerned with the upcoming bad
news had already acted and sold their stocks way before. On the actual rate
hike announcement, the selling pressure has already subsided and the market bounced--because
almost everyone who was scared of the news has already sold before in
anticipation of the announcement.
move in trends
Another assumption of technical analysis is that prices often lean towards a certain trend or bias, and if the
certain direction is already determined there is a high probability that the
market will continue to move in that direction.
Trends are one of the most profitable
aspects of investing and trading. When the market is able to sustain strong buying or strong selling in a
particular stock, then it will lead to trends. Usually these trends are
triggered by a catalyst, see example below.
From 2009, trading at Php 10.00 per share, URC was able to sustain its earnings growth thru its successful products and
expansion in various countries around the world. After 6 years, it reached around Php
180.00 per share. That’s an increase of 1700%. If you invested Php
100,000 at 10.00 php per share,
your stocks would now be worth Php 1.8
This is one example that shows how profitable positioning in up trends can be.
One of the main aspects of Technical Analysis is focused on how to identify and
Patterns form in the markets due to the nature of human beings to react
similarly to certain events and information. In general, we tend to react to
the same events in similar manners, thus the buying & selling behavior of the market participants becomes predictable at a certain degree. Since
prices are determined by the holistic interaction of the buyers and sellers,
the psychology, the emotions, and the actions of the market participants
determines the price where the asset trades.
Every time a stock would encounter a surprise earnings loss people will panic
and the stock will encounter a sell-off.
The price will stabilize once the selling has subsided—often at a price where
it becomes attractive again for the buyers to come in.
Some reactions to negative earnings are short-lived, while some are drastic and
lead to down trends. This all depends on the general market environment, and
whether or not the cause for the losses of the company was due to weakness that
would affect them short term wise or something that would have a long term
negative impact to their core business.
If there is a major incident such as a terrorist attack that
has affected many people in major countries such as the USA, people will tend
to feel fear and the panic will also impact the stock market, even if the
incident has no direct impact to the Philippines, most investors will still
feel the fear and instinctively sell-off their stocks to feel secure.
Again, at a certain point once the panic has subsided the
market will again form a bottom and rebound.
Continuation patterns after a strong upswing
If there is a good news on a stock, it will spike up but at
a certain point will stop and correct because some people would choose to take profits and sell their shares creating a temporary resistance. This is where consolidation patterns such as triangles,
flags, and pennants occur.
The stock will rest for a while, and if the demand for the
stock is really strong it will resume its move and continue to trend up. These
continuation patterns happen all the time and if the trader knows how to
recognize this pattern he can earn profits from these set-ups.
We hope that you learned and enjoyed our feature on the Basic Principles of Technical Analysis. Stay tuned for our next segment focusing on Price Action.
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