What is Technical Analysis?

The Underlying Principles of TA

Posted by Investagrams on October 13, 2016

What is Technical Analysis?

Investagrams on Stocks Oct 13, 2016 • 12:01am
Like us on Facebook

Technical Analysis

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 Technical Analysis 


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 participants.

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.



2. Prices 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 MILLION.

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 trade trends.



3. History repeats itself.


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.


Examples

Disappointing earnings

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.

Major Catastrophe

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.

For more helpful Investing and Trading articles You may follow us on our FB Page: Investagrams

If you want to learn more about trading feel free to register in: www.Investagrams.com



49,316 Views
Investagrams

One stop shop to financial freedom. Your Journey to Success Starts Here. Learn how to invest in stock market for FREE.

Don’t miss any updates from Investagrams