A. WHAT IS TECHNICAL ANALYSIS?
Technical analysis involves plotting the price of a stock, tick by tick, on a chart along with its volumes.
The X axis reflects the time, the Y Axis the price, and the volumes are displayed in a separate section. Check this image out to figure out the elements:
Now, Technical Analysis studies the changes of price and volumes over time.
Mathematicians, stock researchers, academics have created many formulas that extrapolate these elements and provide buying or selling signals.
You may have heard about Moving Averages, Relative Strength Index, Bollinger Bands, etc. – these are the names of different formulas.
Each formula works on all or some elements (price, high, low, change over previous price, volumes, number of periods, etc.) to provide buying or selling signals.
In one sense technical analysis is the study of human behavior in response to fear or greed.
B. What Are Technical Indicators and Do These Work?
Technical analysis attempts to forecast the price movement by applying a formula to the price, volume and time.
This formula is referred to as a technical indicators. As stated above, there are many technical indicators available for free.
No technical indicator is perfect and every indicator does signal a false positive every now and then.
Therefore, it is best to work with a set of 3-4 indicators. If majority of these suggest a buy or a sell, only then you should act.
C. What Should I Study Before Technical Analysis?
D. When Does Technical Analysis FAIL?
When it is applied to cash stocks. Remember that Technical Analysis works only with extremely liquid stocks that feature in the FNO section because such stocks can be quickly traded without much drama being enacted in the price.
Cash stocks can be easily manipulated and should not be analyzed on the charts.
If you are using charts to study cash stocks, you are playing with fire.
When unexpected or unpredictable news hits a liquid stock, Technical Analysis does not work. You have seen many examples of liquid stocks such as Fortis, PC Jewellers, JP Associates, Rcom playing out in the recent past.
When good or bad news hits, the stock either gaps up or gaps down and all you can do is watch from the sidelines.
Emotions and Impulse
When you get all emotional and impulsive and act immediately without getting the trading signal confirmed by more than 2-3 indicators.
E. The Time Period On a Chart
F. Minimum Time Period To Be Analyzed on Charts
G. Validity Of A Technical Analysis Forecast
H. Types of Charts
Beginners should focus on 3 basic types of charts and lot bother about others. They can study the other chart formations after developing proficiency in TA.
LINE CHARTS: The closing price per time period is plotted on the chart.
OHLC (Open-High-Low-Close) CHARTS:
Open-High-Low-Close (OHLC) OR BAR charts show the open, high, low and close prices. The image above will help you understand what these imply.
These are easier to understand than the OHLC charts and it is highly recommended that you work with Candles as you begin your TA journey.
The volumes are plotted below the X-Axis (Time) and this is an important indicator.
For example, a Rs 10 rise in the stock with very low volumes need not imply anything (and vice versa).
However, a Rs 3 rise in the stock price accompanied by heavy volumes can suggest bullishness (and vice versa).
Therefore, it always makes sense to correlate volumes with price.
This post will help you understand how charts are constructed. The next suggested reading should be how to figure out support and resistance levels.
All the information above will help any beginner understand the basic construct of charts and know what time periods to apply.
Once you are done here, you should start understanding technical indicators and learn how to apply these in real life. I keep explaining each indicator on my blog, and you can always keep coming back for more.