Technical analysis is the study of market action primarily through the use of charts, for the purpose of forecasting future price trends.
The term “market action” gives us three key pieces of information which are price, volume, and open interest.
Price tells us about the momentum & direction of a stock and where it is bought or sold.
It also gives us an idea of the volatility and where the support and resistance areas are.
Open Interest & Volume:
Volume and open interest are simply measurements that indicate the liquidity and activity of contracts in the options and futures markets.
Volume refers to the number of contracts traded in a given period and shows the amount of trading activity in a market on any given day.
Open interest denotes the number of active unsettled contracts at the end of any given day.
An increase in Open Interest often means that traders want to enter a position, usually before a new trend or during strong trends.
An increase in Open Interest at that time regularly indicates that a breakout is likely or that the trend will strengthen since more investors are looking to enter a trade.
If more investors become “interested” and are waiting for their orders to get filled, it can foreshadow the flow of money into a market and thus, provide information about investors sentiment.
The 3 Premises Of Technical Analysis
Sound technical analysis is based on 3 premises:
1) Market action discounts everything
2) Prices move in trends
3) History repeats itself
1) Market Action Discounts Everything
Many experts criticize technical analysis because it only considers price movements and ignores fundamental factors.
Technical analysts believe that everything from a company’s fundamentals to broad market factors to market psychology is already priced into the stock.
This removes the need to consider the factors separately before making an investment decision.
The only thing remaining is the analysis of price movements, which technical analysts view as the product of supply and demand for a particular stock in the market.
Technical analysts believe that prices move in short-, medium-, and long-term trend.
Prices move in 3 types of trends
3: History tends to repeat itself
Technical analysts believe that history tends to repeat itself.
Most traders will classify themselves as either a technical or a fundamental analyst.
A fundamental analyst will study all the relevant factors affecting the price of a market in order to come to an intrinsic value of the said market.
A technical analyst concentrates on the study of market action only.
Many analysts have a working knowledge of both ways to analyse the market, and although most traders call themselves technicians or fundamentalists, there tends to be a great deal of overlap.