Why Should I Know Technical Analysis?

Posted On 15 Jul 2014

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Last week, I replied to a question posed from a student. I enjoy receiving these questions as it allows me to gain feedback from students and also keeps me sharp as an instructor. Another popular question I receive is, “Will Online Trading Academy’s technical analysis techniques work on Indian markets?” The answer is a resounding yes and is obvious if you understand what trading is all about.

Most people incorrectly assume that trading is all about understanding the fundamentals of the market or knowing the balance sheet of a company. It doesn’t have as much to do with that as it does with understanding people. People’s perceptions or expectations of a company or even the entire economy are what drive prices of securities. Prices of equities, commodities, and currencies are all subject to the same laws of supply and demand as is any other product. In fact, this is why you will often see prices drop after a company meets expectations for an announcement. The demand for the shares prior to the release overwhelmed the supply. Sellers realized this and raised their prices they were asking for shares. Buyers, in a desperate attempt to own shares, will raise the amount they are willing to pay for them.

For instance, if Tata Motors sells a larger amount of cars than expected, but traders have already anticipated this, then the price will not move up as you might expect. The traders who were expecting positive sales results have already bought their shares prior to the announcement. This should have caused a rise in price for the reasons I stated above. Once the data is known by everyone and there is no surprise, some buying may come in. However, the traders who already own shares are disappointed that the price isn’t rising more or they are satisfied with their profits and begin to sell. Without increased buying pressure from interested parties, these sellers must drop their price to attract buyers to take their shares.

So you see how human emotion, basically fear and greed, will motivate traders to act in the market. This is what causes price movement. So to be successful in trading, you need to know how to read this emotion and the strength of it. That is what technical analysis does. The charts show us the actions of the traders who are involved in that security. In looking at candlesticks and technical tools, we can read the strength of the emotion of those who will move the markets. We can see when this emotion is shifting and leading market turns.bullish candles

We can read the price candles for much of this information. If you are in a bullish trend that you expect to continue, you would expect the share price to close at or near to the high of the day or the high from several days. You would be seeing green candles on your chart with very few or small topping tails.

If price closes away from the highs, then the buying pressure has weakened, or selling pressure has gained. Either way, it is not good for the people holding the stock long. If there is a close that occurs significantly far from the highs, it could signal a possible change in trend.

The same applies to when selling pressure is gaining or weakening. You would expect a very weak stock to be closing at or near the lows. If it doesn’t, then buyers are strengthening or sellers are weakening or both are occurring. So by viewing traders’ actions in a graphical format, we can make assumptions about the strength of the movement of the stock price. These observations are part of our decision making process to time proper entries and exits in the market. That is what technical analysis can offer you as a trader or investor.