Method of analysis the stock market by studying historical chart pattern of stocks which are available in public domain is called Technical analysis of stocks. This method of analysis is mainly use for equity shares but can also be used for some other types of securities .
We can also say that Technical analysis means predicting the stock price by analysing the previous trends of price and volumes using their charts and other technical indicators also. This method is generally used by traders who wants to make quick money by analysing patterns of stock prices.
These kind of traders do not concern about with the overall performance of a company and also do not interested in knowing the basic information about the company before investing in it.
Technical analysis method evolved from the theories of Charles Henry Dow, who is also known as the Father of Technical Analysis.
Behind this whole concept, there are three Dow’s theories which provide the basic assumptions behind technical analysis.
Now you must have question that how to do technical analysis of stocks .
BASICS ASSUMPTIONS OF TECHNICAL ANALYSIS:
For using technical analysis method to predict stock prices, we have to make assumption that there is relationship between historical chart patterns and future stock prices. This is the only and best way to use historical data to predict future prices. Briefly there are three basic assumptions in the technical analysis of stocks.
1. MARKET PRICES REFLECT ALL THE INFORMATION ABOUT A STOCK :
As we said earlier that fundamental analysis concerns about financial and other information about a stock. Although technical analysis of stocks completely detached from fundamental analysis, works on a similar assumption.
Technical analyst believe that all investors are aware of everything about a stock. They actually use this information at the time of buy/sell decisions making.
This information eventually gets reflected in the stock’s price and ultimately in the stock chart. This is why they only study chart patterns to measure market trends, and not think about basic factors of company.
STOCK PRICES FOLLOW TRENDS :
Technical analysis of stocks is works on the idea that each stock chart has its own different trend. Prices of stock move only within this trend. Every move in the stock price will reflect the next move of the stock price. Let’s take the imagined example of a ripple.
When a person throw a stone in a pond, it is obvious that consecutive ripples will get formed as soon as the stone hits the water. Then after few ripples, the trend will decrease and eventually die out. However, the next time you throw a stone, a familiar ripple will appear again.
likewise , even for stock charts, you know the trend from past experiences. organically, the move in either direction may be larger or smaller than before, just like ripples. If a person throws a larger or a smaller stone, ripples too will be larger or smaller respectively. However, the pattern of these ripples will not change completely.
PATTERNS TEND TO REPEAT THEMSELVES:
The last but not the least assumption that argue technical analysis is that trends are repetitive. Let us suppose a stock chart moves in an imagined pattern- A-B-C. So, each time we reach ‘C’, we will again start from ‘A’, and then go to ‘B’ and then last ‘C’. This pattern of stock will repeat itself without fail.
once you make this assumption you can predict future stock prices based on technical analysis. Without this assumption, there is no other way to tell where the price will go next by simply looking at a chart.