What Is Technical Analysis and Why is it Important?

When Technical Analysis is mentioned, what is the first thing that comes to your mind? Is it a guy with a pocket protector wearing a pair of glasses taped together, scribbling away at complex formulas? Perhaps it is a man with slicked-back hair and a black suit and tie, sitting in a cubical, crunching numbers at a computer. While these two movie stereotypes are usually what we think of, a technical analyst can be your next-door neighbor, or perhaps even the casual-dressed lady sitting at the coffee shop this morning. Let’s take a look at technical analysis for stock trading and what information can be concluded from it.

What is a Technical Analysis?

Technical analysts are always looking for price patterns and trends in financial markets. Once these trends are developed and brought to light, they are exploited in a way that the analysts base their buying and selling on the projections of the trends down the line. The biggest tool for these technicians is the price chart, which they study and on which they base many of their assumptions.

The technical analysis bases projected volume and price off of moving averages, lines of support, resistance, balance days, and even flags and pennants. These items and other indicators, which are typically mathematical formulations of price or volume, help to determine if an asset is trending and if so, the direction; up or down.

What are the Objectives?

The technical analysis helps to forecast price movements, which makes long term returns positive through proper risk control. By understanding where the market is moving, the analysts can determine where the few large positive gains will be versus the numerous, smaller gains or losses. The larger gains will outweigh the losses by sheer magnitude, if done correctly.

While there are several different schools of thought for technical analysis (different theories of charting), many stock traders combine elements from multiple schools in order to get the best of each thought process. The objective of the technical analysis it to determine which stocks, markets or indexes would be the most valuable for traders. While no one can ever be completely sure of how much a market will rise or fall, analysts can have an idea if the markets will generally have a rising or falling pattern.

In the Final Analysis

Technical analysis is generally contrasted with fundamental analysis. While fundamental analysis focuses on subjective information, technical analysis uses objective data that a company produces or displays in the market. Technical analysts operate under the assumption that strong data numbers are better suited for determining markets. However, fundamental analysts believe that, while data is good, it is based more on the standing of the company with people who have emotions and feelings.

Neither of these types of analysis are wrong, and they each have their strong arguments. If you like numbers and data, then dealing with a technical analysis is probably something you would understand and enjoy. Learning how to read and understand a technical analysis is beneficial to learning how to invest wisely in the stock market. Arm yourself with as much information as possible in order to relax and have fun with your investment.

By David Moore