Basics Of Technical Analysis

Introduction:

Technical analysis is the study of prices, with charts being the primary tool. Traders use technical analysis to predict the future movement of a stock or index with the help of certain indicators, charts, chart patterns, volume etc.

Charles Dow laid the roots of modern-day technical analysis. Some of the principles observed in Dow-Theory are:

• Price discounts everything – Whatever price you are seeing now, has all the information going on in the stock or index.
• Trends are confirmed by volume.
• Trends exist until definitive signals prove that they have ended etc.

The price of a security represents the demand and supply at certain point. It is the price at which one person agrees to buy and another agrees to sell.

Basic Terminology:

Open: This is the price of the first trade for the period. For example, in an intraday chart this price is the first price at which trading starts for the day.

High: This is the highest price that the security traded during the period. For example, in an intraday chart this price is the highest price attained by the security for the day. This is the point at which there was selling pressure i.e. the security had more number of sellers than buyers at this price.

Low: This is the lowest price that the security traded during the period. For example, in an intraday chart this price is the lowest price attained by the security for the day. This is the point at which there was buying pressure i.e. the security had more number of buyers than sellers at this price.

Close: This is the last price that the security traded during the period. . For example, in an intraday chart this is the last price traded by the security for the day.

Volume: This is the number of shares that were traded during the period or number of shares that were exchanged between buyers and sellers. According to Dow Theory movement in price should be supported by reasonable volume.

Open Interest: Open Interest denotes the number of contracts that have open positions in the market for a future or option. In other words contracts have been initiated but are not closed or exercised and still open in the market.

Bid Price: This is the price that a buyer is willing to pay for a share.

Ask Price: This is the price that a seller is willing to accept for a share.

The above definitions are not just a mere technical analysis vocabulary but can individually act as powerful technical tools in themselves.

Technical Charts: There is a wise saying that a complex idea can be conveyed with just a single image. Similarly, Technical charts act as a single point of information for the historical and present movement in price.

Types of Charts:

Let us look at some basic forms of charts used by traders.

Line Chart: A line chart is drawn by connecting the closing prices of a security during a period. In a Daily time frame chart, a line is drawn by connecting close price of each day. Similarly, in a 5 minute time frame a line chart is drawn by connecting the close of price of a security every 5 minutes.

Bar Chart: A Bar chart displays open, high, low and close price of a security on a single bar. Displayed below are pictures of bearish and bullish bar. A vertical bar has two ticks attached to it, one on the right (close price) and one on the left (Open price). If the open price is higher than close price, the left tick will be higher than right tick and is termed as bearish bar. Similarly, if the open price is lower than close price, the left tick will be placed lower relative to the right tick and is termed as bullish bar.

Below displayed is an intraday bar chart.

A bearish bar has its open higher than its close. A bullish bar has it close higher than open.

Candlestick Chart:

Candle stick charts are similar to bar charts in a way. The only difference is that the open and close prices are displayed with in the body of the candle rather than a tick. Depending on whether the bar is bullish or bearish, colour of the candle’s body change. A bullish bar has its body coloured green/blue/white. A bearish bar has its body coloured red/black.

A bearish candle has its open higher than its close. A bullish candle has it close higher than open.

Check details of our Advanced Technical analysis course