A detailed explanation of Technical Analysis!!
In the last module, we discussed fundamental analysis. We dived deep into the concept and figured out the process of performing fundamental analysis, reasons why it is important, and more. In this module, we will study the Technical Analysis and various aspects related to it. Basically, in this chapter, we are going to discuss the concept and history of Technical Analysis. Besides, we will also learn how technical analysis differs from fundamental analysis.
The Concept of Technical Analysis
Technical Analysis (TA) is a method of analyzing financial markets and choosing investment strategies. TA is one of the two main approaches along with the fundamental analysis to analyze markets and involves looking at past performances of the market in terms of price movements, moving averages, volume, and several outcome statistics.
Technical analysis is the science of recording, especially in graphic form, the actual history of trading such as the volume of transaction, price changes, etc. in a specific stock or financial assets and then determining from that pictured antiquity the probable future trend. As we studied, fundamental analysts examine assets, earning, dividends, quality, earnings, ratio, research, and new products.
However, technical analysts also employ various tools and techniques or methods one of which is the use of charts. With the help of charts, technical analysts look to determine market trends and price patterns in the financial markets and try to employ those patterns.
Technical Analysis versus Fundamental Analysis
Technical analysis and Fundamental analysis are quite different from each other. Unlike fundamental analysis, TA doesn’t tend to measure the intrinsic value of a security. Rather, it determines various market patterns to use as a base for investment decisions. Besides, it takes various multiple forms with some technical analysts using technical indicators and oscillators.
Some depend on chart patterns while some use a mixture of the two. Trading data from the past is the only thing that matters in technical analysis. Analysts don’t consider the value of the stock when predicting future price movements.
Apart from these, there are several other differences between technical analysis and fundamental analysis. They are as follows:
Tenure: Technical analysis' scope varies from very short (daily or weekly) to midterm (monthly or quarterly). However, the scope of fundamental analysis includes a long-term perspective of at least one to years while assessing security.
Data: Technical analysis considers the past price movements and trading patterns of security to predict its future course. On the other hand, fundamental analysis analyses the company's business model, financials, prospects to ensure its future price, and profit growth.
Investor Type: Technical analysis is useful for you if you are a short-term investor, day trader or a hedger seeking instant gains from stock. While fundamental analysis is beneficial for investors who wish to create wealth over the long term by holding and buying securities.
Assumptions: In technical analysis, the stock price is assumed to move along a fixed pattern and trend as it has done in the past. However, in fundamental analysis, the stock price is assumed to be determined by its intrinsic value and the company's future earning potential.
Investments: Technical analysis can be used for any tradeable financial security-equity shares, forex, bonds, futures, and commodities. On the contrary, fundamental analysis can be used only for a thin range of instruments such as stock indices, commodities, and shares.
Information flow: In technical analysis, it is limited to those who are conversant with the idea and have access to the required tools. On the other hand, information flow in fundamental analysis is available to all investors through annual reports of the company, brokerages, stock exchange websites, and media reports.
As far as the history of technical analysis is concerned, it is very poorly recorded since no evidence of it being used is found. However, it can be perceived that this ancient method of examining markets and prices were used in the distant past in freely traded markets.
Japan is the first place where recorded technical rules used in the technical analysis have been found. Many historians suggested that technical analysis began in the rice markets in Japan. A rice trader named Homma Munehisa in Osaka observes that rice traders and farmers had extreme difficulty in predicting the price of rice. On close observation, he found that the price fluctuations were specifically due to the emotions of farmers and traders. So, he considered understanding their emotions and psychology first.
Homma found out how traders and farmers made their decisions about selling and buying rice. He began recording the prices of rice at every moment. Homma recorded every high and low of rice at specific times. After some time, he found that the fluctuation in the rice prices formed a kind of pattern and they were repeating continually. He observed each pattern carefully and started naming them.
Then, he created a chart of those patterns that helped him in understanding the psychology of farmers and traders. He started using this technique in rice trading and very soon he became a successful trader. Other traders also started using the same technique and they too got an impressive return. Homma's strategy and charts for buying and selling rice are the foundat6 of Japanese Candlestick Chart which was used later to trade various other things.
Modern Technical Analysis
Nevertheless, the practise of technical analysis likely dates back in some forms many centuries, Charles Dow was the first person to comment and reintroduce it in recent times. Charles Dow is known as the father of modern technical analysis. His introduction of stock indexes to analyse the stock market's performance for a major advance in the sophistication of stock market participants.