We briefly explained what Technical Analysis was in the previous chapter. This chapter will be about the flexibility and assumptions that Technical Analysis allows.
Technical analysis has the unique ability to apply TA to any asset class, provided that it has historical time series data. In a technical analysis context, time-series data refers to the information about price variables, such as open high, low and close.
This analogy may be helpful. Consider learning to drive a car. You can drive any car once you have learned how to drive it. Technical analysis is also a one-time requirement. Once you have completed this, you can use TA's concept to any asset class - equities or commodities, fixed income, foreign exchange, and so on.
This is one of the greatest advantages of TA over other areas of study. Fundamental analysis of equity requires one to examine the balance sheet, profit and loss, and cash flow statements. Fundamental analysis of commodities, however, is a completely different matter.
The fundamental analysis, analyzes rainfall, harvest, Demand, and supply, etc to deal with an agricultural commodity such as coffee. The fundamentals of metal commodities and energy commodities are very different. The fundamentals of a commodity change every time you select it.
The concept of technical analysis is the same regardless of what asset you are studying. An indicator like 'Moving average divergence (MACD) or a 'Relative strength indicator' (RSI), can be used on any asset, commodity, or currency.
Technical analysts are not like fundamental analysts and don't care if a stock has a low or high value. The only thing that matters are the stocks' past trading data (price, volume) and the information these data can give about future movements in the security.
The basis of technical analysis is based upon a few key assumptions. These assumptions are essential to get the best results.
1) Markets offer a discount on everything This assumes that all information available in the public domain, known or unknown, is reflected in the stock price. In anticipation of good quarterly earnings announcements, an insider could buy large quantities of stock. The insider does it secretly, but the stock price reacts to him, making this a possible good buy.
2) The how' is more important than the? why? This is an extension of the first assumption. The same as the previous example, the technical analyst wouldn't be interested in questions why? The insider bought the stock for as long as he knew how the insider's actions triggered a reaction by the market.
3)Trend: A trend is the result of all major market moves. Technical analysis is based on the concept of trend. The recent increase in the NIFTY Index from 6400 to 7700 did not occur overnight. This gradual move took place over 11 months. You can also look at it this way: once a trend has been established, prices move in that direction.
4) History tends not to repeat itself -The price trend is a predictable one in technical analysis. Because market participants react in a similar way to price movements, each time they move in a particular direction, this is because they are consistent. Market participants are greedy in up-trending markets and will buy regardless of the price. Market participants will also want to sell in a downtrend regardless of low or unattractive price points. This human reaction ensures that price history repeats itself.
The Indian stock exchange is open between 9:15 and 03:30 pm. Millions of trades are executed during the six-hour, 15-minute market session. Consider a stock as an example. Every minute, there are trades that are executed on the exchange. Do we as market participants need to keep track of all the price points where trades are executed?
Let's take a look at this stock, which is an imaginary stock that can be traded. Take a look at the image below. Each point represents a trade executed at a specific time. A graph that includes every second between 9:15 AM and 3:30 PM will become cluttered with too many points. The chart below shows a time period that I have limited control over.
The market opened at 9:00 AM and closed at 3:00 PM. There were numerous trades during this time. It will be difficult to keep track of all the different price points. It is not necessary to have all details about each price point, but a summary of trading activity.
We can summarize the price action by tracking the Open, high and low, as well as the close.
The opening price is the price at which a trade can be executed when the markets are open for trading.
The high -This is the highest possible price that market participants would be willing to pay for the day.
The Low -This is the lowest level that market participants were willing and able to transact on a given day.
Because it is the closing price of a market, the Close price is most important. The close is an indicator of intraday strength. If the close is greater than the open, it is considered positive or negative. As we move through the module, we'll be addressing this issue in more detail.
The closing price is a measure of market sentiment and serves to guide traders in the coming day. The closing price is, therefore, more important than the Open or High prices.
Technical analysis perspectives focus on the open, high, low, and close prices. Each price must be plotted and analyzed.
This chapter contains key takeaways