There are two methodologies for analyzing the stocks trading in the secondary market. One of that is fundamental analysis which involves study of the financial strengths of the company whose stock is picked up. The other one is the technical analysis which is based on the on-going happenings in the market which impact the short term price moments through demand and supply of the stock.
What is Technical Analysis?
Technical analysis is all about studying stock price sequences, impact of the volumes traded, price pattern, trends of the stock, news impacting the stock in particular, news impacting the industry/geography to which the stock operates etc.,
Technical Analysis comprise of various techniques to study the price action over a period. The technical analysts need to be very vigilant to the happenings around the globe which may impact the stocks which they are tracking.
The technical analysts do not believe in study of the intrinsic value of the stock but believe in making short term profit by analyzing the volume and pricing of the stocks by looking at the trends and forecasting this movement with the expected reaction of the stock to the global happenings which can be specific to the company or specific to the industry to which the company pertains or the news which may impact the business environment or economy of the country in which the company operates.
How is it different from fundamental analysis?
The fundamental analysts look at the basic foundation of the company [Balance sheet, Income statement, Cash generations etc.,] in order to analyze the strength of the stock whereas the technical analysts predict the price moments of the stock by relying on the past trends and the impact of the contingent events which may impact the company. Thus the first one is the cause driven and the latter one is the effect driven.
If fundamental analysis was the only or most reliable method of indicating / predicting the prices, the prices would predominantly fluctuate only 4-5 times a year around the time of quarterly results announcements dates, any merger announcements, new business announcements etc.,
If such is the case, then the prices of the stocks should more over remain the same throughout which is not the case.
Characteristics and principles & techniques
Technical analysis is widely used among traders and financial professionals and is very often used by active day traders.
Technical analysts believe that prices trend directionally, i.e., up, down, or sideways (flat) or some combination. They employ many techniques, one of which is the use of charts. Using charts, technical analysts seek to identify price patterns and market trends in financial markets and attempt to exploit those patterns. Technical analysts use various methods and tools, the study of price charts is but one.
Technical analysts using charting methods such as head and shoulders or double top/bottom reversal patterns, study technical indicators, moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants, balance days and cup and handle patterns. These concepts can be heard very often in business channels and business newspapers.
Supports refer to the price level through which a stock price is not expected to fall and resistance is the price level which a stock is not expected to surpasses. Breakout refers to point when the price actually falls below the support level or rises above the resistance level. Once a breakout occurs, the role is reversed. If the price increases beyond the resistance level, the resistance level becomes the support level and when the price falls below the support level, the support level becomes the new resistance level for the stock. Momentum refers to the rate at which price of a stock changes.
Technical analysis tool was used both, on the spot, mainly by market professionals for day trading, as well as by general public through the printed versions in newspapers showing the data of the negotiations of the previous day, for swing and for taking positional trades.
Despite to continue appearing in print in newspapers, as well as computerized versions in some websites, analysis via quotation board is another form of technical analysis that has fallen into disuse by the majority. Improper analysis, wrong interpretation of the trends, events happening suddenly which were never foreseen will only take away the investment of the investors relying on the data. Clear example of an unexpected impact was with the stock Satyam computer services limited on 7th Jan 2009 when the fudging of books was admitted by the company erstwhile management. Any decision for investing based on the “Stock tips” should be made only after proper understanding of the risks involved and after getting certain confidence level on the technical analyst.