What is technical analysis?
Technical analysis is a methodology that is used when you want to try to predict a share’s future price development but also to create rules for money / risk management.
Understanding technical analysis
When using technical analysis, the focus is on movements in stock trading to determine whether a share is worth buying or not.
How likely is it that the course pattern moves in a certain way?
By looking at the share’s movements and how the market behaves, one tries to calculate patterns and behavior in the movements in the share price, this with the help of historical data and probability theory.
Predictability in human behavior is at the very core of technical analysis. We humans often have a tendency to do the same thing over and over again.
The technical analysis does not take into account which industry or country a company belongs to, but only focuses on the share price.
It is assumed in technical analysis that the market has already calculated the fundamental value of the share price, and is simply trying to find buy or sell signals.
As I have previously described above, technical analysis is a method that is used to try to predict the future development of a share. It is thus a fairly complex analysis method that is based on various historical data on how the share in question has previously moved and this combined with probability theory.
This means that technical analysis is also a method in which human predictability is largely taken into account, ie we often repeat the same pattern over and over again.
This repetition of aggregate behaviors is something that the technical analyst believes is already reflected in the course information, which is why this information and the interpretation of these is the basis of the analysis method.
Unlike the fundamental analysis, however, the technical analysis does not consider fundamental information (such as sales, profit development, etc.) about a company. Instead, it is assumed that all such information is already included and reflected in the current share price.
However, there is nothing to stop one from combining technical analysis with fundamental analysis to further improve the likelihood of making good stock deals.
In other words, the focus is on analyzing past movement patterns and the basics of these to try to understand how the stock will move in the future.
Probability theory, historical movements and statistical data can give you an “edge” in your pursuit of returns.
The basics of technical analysis and the reason
As I have mentioned before, technical analysis is a method where you want to try to predict how a share will go in the future.
This method is based on historical price data of so-called market-generated information (ie time, price and volume data) to find repeated movement patterns in a specific share or other asset class.
The reason for doing so is simply because you want to find stocks that show the right conditions for wanting to invest in.
Technical analysis can be used by private individuals and hobby traders as well as large institutional players and advisers.
How to do a technical analysis?
It may seem that technical analysis is complicated, but there are simpler variants that all small savers can use and take advantage of to be able to make informed investment decisions.
Some of the concepts that can be good to know to get started with simpler technical analysis are trends, moving averages and support and resistance.
Trends are one of the most important concepts to keep track of in technical analysis. In short, the trend shows the direction of the share price.
The direction of the course can be rising or falling, but it does not always have to be in trend but can also be in consolidation, eruption or recoil.
However, you should try to identify a trend when you want to find out if it is a buy or buy signal.
It is important to keep track of your time horizon when using trends in your technical analysis.
If you are long-term in your investments, you look more at the long-term trend than the short-term one and vice versa.
Rising and falling trends
A rising trend is defined by a number of rising bottoms and peaks in the share price during a certain period.
The opposite of the rising trend is falling, which is described as a number of falling peaks and troughs.
You can find the trend by drawing a straight line through either the tops or the bottoms. Here you decide the time horizon yourself, and if you are long-term, you choose a longer time horizon.
A stock may be on an upward trend for four years, but at the same time be on a downward trend over a one-year period.
How to use rising trend to find a buy signal in a stock?
How to use rising trend to find a buy signal in a stock? Well, by using probability theory. A stock that is in a rising trend is more likely to continue to rise than it is to fall.
And the same, of course, applies to shares in a falling trend, where the price is more likely to continue to fall.
By studying the trend, you can find a buy signal and buy stocks that are in rising trends and avoid stocks in falling trends.
2. Moving average
To find buy and sell signals in a trend, you can use indicators. These can help you find out if a trend is really rising or falling.
There are many different types of indicators, and many of them are advanced and require a lot of time from you as an investor.
One of the most used analysis tools is the moving average, which is also called MA (moving average). The most basic type is called SMA (simple moving average).
You get the moving average by taking the average of the closing price over a certain number of periods.
It is common to create three moving averages based on three different periods;
- MA200 – a long period of 200 days
- MA50 – a medium-term period of 50 days
- MA20 – a short period of 20 days
How to use moving average?
Using the moving average, you want to find a buy or sell signal in a stock. These can occur when a stock price crosses its moving average.
You can find a buy signal when the share price crosses the moving average from below, and a sell signal occurs when the moving average crosses the share price from above.
Support and resistance
The next step is to identify the support and resistance in the trend, which are levels in the graph where the price turns and changes direction. It can be described as the highs and lows of the stock price over a short period.
By drawing parallel lines at the last bottom and top of a prevailing trend, you can see where support and resistance are in a graph.
- Support = Level in the graph that prevents the price from falling
- Resistance = Level in the graph that prevents the price from rising
In the case of support, it can be assumed that there is a surplus of buyers, and this may be due, for example, to the fact that the share has a fundamentally low valuation at that level, or that it has been seen that the share has turned from that level before.
3. How to use support and resistance?
When you want to buy a stock that is in a rising trend, you can wait for a support level. This usually means that the stock has reached a temporary bottom level, and that you can buy the stock cheaply.
In the same way, you can also avoid buying a stock that is approaching its resistance, as the price will then probably fall.
Support and resistance are usually used as follows:
- Buy when the stock falls against support
- Sell when the stock rises against resistance
- Buy when the stock breaks through resistance
- Sell when the stock breaks down through support
It is good to know that when the price is in the range around and resistance, volatility often increases and there can be large short-term fluctuations.
Therefore, it is often better to avoid placing orders directly on buy and resistance. Instead, place buy orders slightly above support and sell orders slightly below resistance.
Here it is important to remember that there is no guarantee that the course will move within a certain range.
Do I need a program to do technical analysis?
You do not need a special program to use the simpler types of technical analysis. Most banks have functions for basic technical analysis and there you can set up different types of indicators and learn how they work.
If you want to immerse yourself in your technical analysis, there are several good trader programs that you can use.
TradingView has without a doubt the best platform for you who want to test technical analysis.
In addition, you do not need to install any app for it, but it works perfectly directly in your browser on your computer or mobile.
- Price: Free that can be upgraded for more functionality
- Functionality: 5/5
- Difficulty: 1/5
Does technical analysis work?
Opinions differ widely on whether technical analysis really works or not. There is definitely no waterproof method or “holy grail”, but on the other hand, no such methods exist at all.
As the analysis method is based on historical data as well as human behavioral patterns and psychology, there is nothing that can guarantee that the technical analysis works or will work in the future.
There are also many subjective elements and the analysis can be more or less reliable depending on how advanced it is.
However, there are many examples of successful traders and investors who use technical analysis, who can present as proof that the method can be one of several useful tools for success in the stock market.
Technical analysis should be seen as one of several useful tools for shaping analysis scenarios and probabilities for different outcomes.
How do you best use technical analysis when buying shares?
My experience of stock trading is that the biggest gains occur when you buy shares after you have received a “buy signal” in a technical analysis model in an otherwise “fundamentally strong” share.
Contrary to many people’s beliefs, these two analysis concepts are not opposites, and can be combined with great advantage and success!
In its simplest (and perhaps best) form, a technical buy signal can be created by a stock price being able to rise through a level (a price) where it previously turned down.
Let’s look at an example:
A share is traded between $8 and $10 for a few months. But every time it reaches SEK 10, new sellers seem to enter the market and the share price turns back down again.
The fact that the share is turning down from the $10 level is simply due to the fact that there are large sell orders at this particular level.
But suddenly one day the share price manages to rise through this $10 level! and we have now received a classic “buy signal”.
The fact that the price is able to pass the $10 level is due to the fact that the large sellers have now been allowed to sell all their shares – and they are thus no longer in the market.
Now there is nothing to block a continued rise in prices. Many times the upswings become strong after such a process.
This process could explain the price development in Volvo in 2016. Once the share price rises by $10, a buy signal is triggered, and this takes Volvo’s share price all the way up to the $17 level!
A “fundamentally strong” share
A “fundamentally strong” share refers to a company that has recently released a strong quarterly report, which was better than the market had expected, or “received a large or important order”.
My experience of stock trading is also that the biggest losses occur, when we refuse to sell shares that fall, and also add to the fire by throwing more fuel – read: you buy more shares when the share price falls in the belief that you should lower the purchase average and be able to sell to break-even after a small recoil.
This strategy is highly insidious as it usually works as you want, but when it does not work you lose several years of return and many times worse than that.
Do not do that. Shares fall because the sellers are in the majority.
Why in the name of peace would you like to buy shares where the sellers are in the majority? Something to think about for the 3-coffee!
Is there a secret analysis model that makes the user a millionaire?
Another myth that exists is that there would be some secrets within the technical analysis. Unfortunately, I can hereby announce that no such thing exists.
In the same way that there are no secrets in the “fundamental analysis” where you look at profits, margins, cash flow and development opportunities.
For whom is Technical Analysis for?
Anyone interested in the stock market, stocks and investments should give technical analysis a chance. It is not an analysis method that suits everyone, but it is possible to choose certain parts of the method.
Not least, it is important to understand how it works because it is used by many others.
To become good at technical analysis, it is required that you have patience, are prepared to re-evaluate your original condition and that you are interested in psychology and human behavior.
An interest in the stock market and companies is of course also important, but this generally applies to becoming good at stock trading.
Patience is crucial
Patience is crucial as it takes time to learn technical analysis. You can not take a quick look at a graph and think that you can make great stock cuts based on it.
Technical analysis is more advanced than that. However, it is not impossible to learn to do a technical analysis.
There are many good programs that make it easy to handle large amounts of historical data and visualize it in various charts and tables.
It can be a little tricky at first if you have never done it, but after a while it’s actually fun. Like much else in life, practice makes perfect. After a while, it will be faster and smoother to carry out the technical analysis.
You should have a relatively open mind to become good at technical analysis. You must be flexible and prepared to re-evaluate your original assumption based on what the historical data shows.
Keep an open mind
If you are a stubborn person who always has to be right, for example when discussing, it can be difficult to learn this analysis method.
With technical analysis, you often have to re-evaluate your conclusions because there is new information that changes the conditions.
Since technical analysis is based on human herd behavior, it is necessary to have a certain interest in psychology and group behavior.
Being interested in how people work and what it is that makes us make certain decisions will make you more understanding of how technical analysis works.
Some people think this is nonsense, but it is possible to delve into stock market psychology. Remember it is not black or white.
People often behave in a certain way, but there are also situations when people behave irrationally and do not follow logical patterns.
If you think the above description fits you, technical analysis can be a good analysis method for you.
What is the difference between technical analysis and fundamental analysis?
How does technical analysis really differ from fundamental analysis?
Slightly simplified, the difference between technical analysis of shares and a fundamental analysis can be described as follows:
Fundamental analysis focuses on the company’s value by analyzing the company’s finances via various key figures.
Technical analysis focuses on the historical price development and psychology by visualizing the data in graphs and thereby seeing patterns and trends and acting on these.
The opposite of technical analysis is fundamental analysis, also abbreviated FA. Both are analysis methods for analyzing stocks, but they focus on different aspects to make an analysis.
Many investors use both methods.
Unlike technical analysis, fundamental analysis focuses on analyzing the company’s finances. This means looking at the company’s value, assets, reports, sales and other key figures.
They also look at the company’s future prospects to form an idea of what they think the share is worth.
Briefly about the history of technical analysis
Many believe that the first to introduce technical analysis in the Western world was Charles Dow, when in 1896 he teamed up with a friend to create the Dow Jones Industrial Average, named after the creators.
Through his regular contributions to the “wall street journal” that he himself founded, Charles Dow also laid the foundation for what later came to be known as the “Dow Theory”.
If you look beyond the West, technical analysis already existed a century before Charles Downs was born.
In Japan, it is said that technical analysis was born when a Homma Munehisa followed the price of rice, and discovered that there were recurring patterns that heralded the future.
These patterns were later called candlesticks, and are today very popular even in the west.
Areas of application for technical analysis and stock analysis
When it comes to technical analysis, no trader has exactly the same method as another. In other words, it is a subjective science, where there is no direct right or wrong.
Although different traders have different approaches, technical analysis is most often used for roughly the same things.
Here are some examples:
- Identify the trend direction – is it a falling trend or rising trend
- Note important price levels
- Discover good entries
- Set stop loss and profit target
- Know when to exit a trade