Technical analysis is based on the principle that past price movement in a financial instrument is a predictor of the future moves in the price.
Trading volume is often combined with price movement to help improve these price prediction models.
The skills of a technical analyst are used primarily to help determine the highest probability reactions to past and current price movement, as well as likely future price movement.
In this article, our main focus will be to let you know what are the tools used in technical analysis.
Tools used in technical analysis
The primary tool used by technical analysts is the price chart, which plots price over a given period of time.
This is the most basic and certainly the most important tool of technical analysis.
The main function of a price chart is to lay out the shape of price movement over time. It helps technical analysts to project and/or to react to likely future price behaviour.
We have different types of charts available to use. Here are the options available;
- Line chart
- Bar chart
- Candlestick chart
- Point-and-figure chart
The most common method in which price action is structured on a chart are the bar chart and the candlestick chart.
A vast majority of technical analysts and traders use bars and candlesticks to depict price action on their charts.
Beginners are always suggested to go for candlestick charts due to its various advantages.
Stock market can be characterised as a mass of human beings acting on their emotions through the acts of buying and selling.
These emotions such as greed, fear, optimism and pessimism are reflected in price action, that can be seen on any price chart.
Price action refers to the pattern behaviour of price, which can give clues to potential future direction. In other words, price action analysis describes mass market behaviour using patterned price movements on a chart.
In addition to price charts, technical analysts mainly focus on chart patterns. Here are the most popular chart patterns;
- Head and shoulders
- Support and resistance levels
- Trends and trend lines
- Moving averages
- Double tops and double bottoms
- Cup and Handles
- Flag
- Pennant
- Wedge
- Broadening formation
You will find many other tools used within the field of technical analysis, such as RSI, MACD, Stochastics, ADX, moving averages, VWAP, Bollinger Bands, and so on.
These tools are considered as lagging indicators and do not belong under the umbrella of price action analysis.
These indicators and oscillators are mathematically derived from price itself. They might help you to formulate trading decisions, but studying these is not considered to be price action analysis.
In other words, indicators and oscillators are not considered as components of price action as they do not represent price itself.
The other method most investors use to buy and sell financial securities from the stock market is fundamental analysis.
Fundamental and technical analysis are the two methods of examining a publicly traded company to determine the health of its stock.
Fundamental analysis is like taking an X-ray of a company. In it you analyse the internal fitness of an organisation to find out how strong it is. Fundamentals show us a company’s internal strength.
Those who buy and sell on the strength of a company’s fundamentals generally are long term investors, that means these market participants are buying stocks on the strength of a company’s fundamentals.
Technical analysts believe that news events, economic conditions, and market perceptions and emotions, are all reflected in the price action. Therefore, they believe that there is really no need to study all of these fundamental factors. Based on study of price action in the past and present, they try to find clues as to how price may move and react in the future.
