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Technical analysis is the tool that traders use to analyze and trade the markets. Its brother, fundamental analysis is often used by investors to analyze a stock. Although technical analysis is mainly used for trading, investors can also benefit from learning this type of analysis.
Technical analysis uses price and volume to analyze the stock market and sectors and stocks. Since patterns tend to repeat again and again in the stock market, the practitioners of technical analysis can use them to spot profitable patterns.
Studying price and volume is all you need to be able to analyze a market effectively. That's because you are looking at the actions of the market participants. Human emotions are the same 100 years ago as well as today and even the next 100 years. Therefore, many patterns will repeat themselves again and again in the market.
Volume shows commitment by market participants. It involves transactions and therefore stocks have changed hands and ultimately money is being committed. For example, if you see a stock having a volume spike of 1000% it might mean there is accumulation by some smart money.
The chart above shows how the knowledge of technical analysis can be applied to spot stocks about to make monster moves. From August to September and even in November, AAOI had very unusual volume spike days. This gave us hints that the stock was being accumulated. The stock rose from around $12 to $32 in less than 6 months.
Stocks have always exhibited patterns that repeat again and again the market. They are two types of chart patterns:
If you apply yourself and study charts continuously, you will stumble upon many patterns that appear again and again.
The chart above shows how FSM made a head and shoulders pattern. This is a bearish reversal pattern which warns of a decline. True to its predictive value, FSM declined in the coming months.
The derivative of price and volume can also be used to successfully analyze the markets. Many indicators are made from price and volume. Although they are derivatives, they can still give us very useful indication of when a stock is about to turn.
The chart above shows how the stochastics, one of my favorite indicators show that MKC was oversold in January. You can see how the stock bounced higher from there.
While some may say that technical analysis is like looking at a rear mirror to know where you should be going, in the hands of an expert, it can reveal many things about the market. Technical analysis is nothing more than a study of price and volume of a stock. In the process of studying price and volume, you are also actually studying the actions and psychology of market participants.
There is immense value in mastering this type of analysis.
As you progress through this course, you will be amazed at the amount of information and predictive value that technical analysis will give you..
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