USE CHARTS TO PREDICT FUTURE PRICE MOVEMENTS
Analysing what securities to trade falls in to two very broad categories. Fundamental analysis and technical analysis. Fundamental analysis involves analysing the fundamentals’ of the company – i.e. earnings potential, past performance, projected growth. Technical analysis takes a completely different approach, it does not focus or even care about the ‘value’ of the company, or a security’s intrinsic value and it is only interested in the price movement. It evaluates securities by analysing the statistics generated by market activity. Charts versus financial statements!
STUDY SUPPLY AND DEMAND
Technical analysis is the study of supply and demand, trying to analyse market trends, predict supply/demand, and understand market psychology. Its aim is to try to understand the mind set or emotions of the trader or the market as opposed to its components, in order to determine what direction or trend the stock will move. The trader uses a combination of charts and other tools to identify patterns and trends. It is based on three assumptions:
- The Market Discounts Everything – A criticism is that it only considers price movement and assumes that the company’s fundamentals along with broader economic factors and market psychology are already priced in!
- Price Moves in Trends – This implies that after a trend has been established, the future moment is more likely to be in the same direction as the trend than to be against it.
- History Tends to Repeat Itself
The repetitive nature of price movements is attributed to market psychology – Traders tend to react in a consistently and in a similar way to the variety of factors that affect the market.
Like all other types of analysis it has both benefits and limitations. It is more short term in nature and is more for trading than investing although the line between these can be blurry which is why combining technical and fundamental analysis is probably the best road to take.
Jesse Livermore was one of the great stock speculators of Wall Street. His fist job at age 12 was posting prices for customers who were placing bets in a local stock market bucket shop. He studied the patterns and soon he was placing bets himself and winning. He became so successful that all the bucket shops banned his activities. He then began speculating in stocks and legend has it he made four million dollar fortunes from 1890-1940. He studied the ticker tape and was probably the first and one of the most successful technical analysts in the market!