There are a great many ways to analyze stocks, pick the best ones for investment, and decide when to hold and when to sell. One such method is called “technical analysis.” In reality, the name is somewhat misleading, as it does not necessarily rely on technology to produce an analysis; instead, it relies on mathematical and statistical analyses of various sorts. Although many people use technical trading methods, it is especially popular with day traders who seek insight into the smaller variations of an equity’s share price that occur within the trading day.
Technical Analysis vs. Fundamental Analysis
Technical analysis differs from fundamental analysis, which looks at the company behind the stock ticker and its real potential for success. Technical analysis focuses more on analyzing small variations and trends in the stock price movement. It uses many different patterns and indicators, some of which are very complex and seemingly have very little to do with the performance of the company behind the stock and the stock’s true value, nonetheless, several investors claim to have great success with these methods.
Proponents of this method rely heavily on charts that show a stock’s past performance, a factor that almost every investor will use. A student of technical analysis however, believes that everything else being equal, stock prices move according to a predictable pattern that has nothing to do with underlying fundamentals. Regardless of whether one believes in the presence of these cycles, the charts that technical analysts generate can be useful tools in analyzing a stock’s past performance and making decisions about its future. The ubiquitous bar chart, for example, is very useful for day traders, since it shows not only trends over time, but also the high, low, opening and closing prices for each day. A look at a bar chart will quickly tell whether a given security would be a good candidate for day trading.
A more complex variation of the bar chart is the candlestick chart, originally invented by the Japanese hundreds of years ago to analyze the value of rice contracts. Notoriously complex, these also incorporate colors and up to 20 different patterns to show inter-day and intra-day fluctuations.
There are hundreds of different methods of technical analysis. While investors do tend to have their favorites, the best investors will look at more than one type of technical chart, “back-test” it to see how the stock reacted to patterns in the past, and combine it with fundamental analysis to gain a better understanding of the true strength of the company. The best strategy is to use technical analysis as a supplement to, but not a replacement of fundamentals; using technical analysis alone disregards the fact that each equity is in reality much more than a collection of charts; it has a whole company behind it, with people making decisions, products being sold and marketing initiatives being rolled out daily.
Information is for educational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.