Fundamental analysis and technical analysis are the two methods used by the traders in order to predict the price movement and base their investment decisions on such price volatility. While the fundamental analysis is mainly based on the dividends, price of products, research and so on the technical analysis is a study of the price movement of stocks based on historical market information like the price and the volume. It studies how the customers will react for a change in the price and so on. The technical analysis is done using various tools as well as market indicators. As per this analysis the prices will have a direct impact of any changes in the trends of a market. The traders will become aware of such changes only after they realize the price changes in the stock.
Most of the technical analysis models are basically design with the relationship between the price and volume. Though there are lot of disputes with the use of fundamental analysis over the technical analysis but still the brokers and big volume traders make use of the technical analysis for basing their investment decisions.
The analysis is based on a principle that the price is a factor that will reflect all the changes and trends of a stock and so a detailed study of the price changes in the past could easily be utilized for making future investment decisions. This means that every time there is a change in the market the investors will react to such changes in the similar manner only and thus such historical changes can be used as a reliable base.
There are certain assumptions based on which the technical analysis will hold well and those are explained below:
Market discounts all the factors:
The technical analysis assumes that price is the all pervasive factor. It will reflect all the various factors affecting the company like the economical factors, changes in the company’s fundamental aspects, psychological changes of the investors, and general market information. So all these aspects are already incorporated in the price movement and so a separate study of these factors is not required.
Trends and price move side by side:
Another assumption is that the price of the stock will have a direct relation to the trend. If the trend is positive then there will be a positive change in the stock price while if the trend is negative the price change will similarly negative. So the price changes are directly correlated to the trends.
Repetition of the history
Another major assumption is that the technical analysis believes that the history of the price movements will repeat itself. The reaction of the investors towards particular stimuli will be the same when the same situation is repeated. The analysis is based on many kinds of charts and tables which have been used for several years. But the traders and the brokers still believe that such year’s old mechanism is still relevant in current market scenario.
There are basically four types of charts which form the tools for the technical analysis namely:
- Line Chart
- Bar Chart
- Candlestick chart
- Point and Figure charts
Line Chart:
The chart considers only the closing price of the stock and that is plotted for a given time period and they are connected to form a line. This line will depict the price changes over a period of time but does not provide a visual presentation for the trader. However the closing price is considered to be the most important factor much more than the low and high price of the day.
Bar Chart:
The chart will contain the low and high for the trading day along with the opening and the closing price in the form of vertical lines. The dash on the left side depicts the opening price while the dash on the right side of the vertical bar will depict the closing price.
Candlestick Chart:
It’s just like the bar chart wherein a vertical line is drawn based on the high and low of a time period. But the major change is in the bar that is drawn n the vertical line which will show the difference between the opening and closing price. It gives a visual representation of the price movements for the trader.
Point and Figure charts:
Though not commonly used but it’s the oldest method of all. Though the chart reflects the price movements but it does not take time and volume factor into consideration and so not a very reliable method for technical analysis.