Chapter 1: What is Technical Analysis?

Chapter 1 -  What is Technical Analysis?

A very important disclaimer before dwelling in the world of Technical Analysis:

“No tools or techniques or analysis guarantees perfect results. But with the help of tools available for technical analysis, one can make more informed decisions about the trades which they are entering into. And which in turn enhances the chances of being right while taking a trade”

So what is Technical Analysis (TA)?

Technical Analysis is a trading discipline which is used to make an informed judgment to evaluate investment and trading opportunities​. TA is a form of Statistical tool which helps us in understanding the trends gathered from information like the price movement and volume​.

So, in simple terms, Technical analysis is a tool to understand and forecast the price trends of any stock (or share) by using price and volume as the basis. Technical analysis can be used while trading stocks, derivatives, commodities, fixed-income, currencies, and other securities. 

What to expect while using Technical Analysis?

Having realistic expectations is of utmost importance while using any form of analysis, let alone technical analysis while trading. Following are some of the ground rules to be followed while doing technical analysis:

  • One should not expect Miracles while using Technical Analysis. These are tools to enhance the trading decisions taken by the trader. But these do not guarantee any success. 
  • The indications provided by Technical Analysis are relevant over a short period of time. The signals keep changing over time. And as we are aware that investment is over a period of time and trading is more short-term by nature. So, technical analysis is more useful while trading than while investing.
  • The time of entry and exit of the trades should be pre-decided at the time of entering the trade. And throughout the holding period of the trade, these pre-decided levels should be followed and respected. So, in simple terms, Discipline is of [utmost importance while using Technical Analysis.

Hypothesis while using Technical Analysis: 

  • Markets just react to Price Action​. The movement in the prices over the period of time lays the foundation for the development of Technical Indicators. And buying and selling at those levels sets the foundation for the development of technical levels around them.
  • TA does not question the rationale, it merely reacts​. Whether the share price is overbought or oversold is not questioned by Technical levels. It merely makes a judgment based on price action and volume
  • TA price movement is trend-driven​. Technical Analysis works on the theory of trend being the driving force behind the formation of Technical indicators. So treating the trend as the king is of utmost importance. 

Indian Stock Market:

Indian Equity market functions from 9:15 am in the morning to 3:30 pm. And it sometimes becomes difficult to keep a track of all the price movements of the day. But if we are aware of the following four components, then we can have a good understanding of the price action of the day:

  • Open (O) - This is the price of the stock at which the first trade for the said stock is undertaken
  • Low (L) -  This is the lowest price of the stock at which the trade was executed
  • High (H) - This is the highest price of the stock at which the trade was executed during the day
  • Close (c)  -  This is the price at which the last trade for the said stock was executed for the day