What is Technical Analysis?

In stock trading, Technical Analysis is the use of stock charts to try to predict where the price of a particular stock will head next by picking out support and resistance points and identifying trends.

Technical analysis simply looks at price action alone and pays no attention to the underlying fundamentals such as the state of the economy or company profits.

There are many important factors to be considered when performing technical analysis on a particular stock including:

Support and Resistance

Support is a price where there is expected to be pressure from buyers. Conversely resistance is a price where there is expected to be pressure from sellers.

Now we can take a look at some of the methods technical traders use to determine these important support and resistance points.

Fibonacci Retracement Lines

Fibonacci Retracement lines are drawn from two price extremes. Usually a previous high to a previous low or a previous high to a previous low. When the line is drawn, points between the high and low are marked, commonly at 23.6%, 38.2%, 50%, 61.8% and 100%. The chart below shows Fibonacci Lines marked on a Microsoft chart:

Points can be drawn at any percentage but other common points are drawn at 78.6%, 161.8%, 261.8% and 423.6%.

Fibonacci Retracement lines can be drawn from price extremes on any time frame.

Now, let’s get back to support and resistance. Fibonacci lines often act as support and resistance points. The market will often “bounce” at these points. This means there could be a temporary pause in a trend due to pressure from buyers or sellers at these support or resistance points.

In some cases, major support and resistance points can even be a point where the market reverses and changes direction completely.

Trend lines

Trend lines are drawn connecting at least two price points. Using the same chart again, we’ll draw an ascending (upward) trend line. As you can see the trend line is drawn from two points on the chart.

Trend lines can also provide support and resistance points. Some traders buy or sell stock when price hits their trend line

Trend lines also give a clear indication if there is a trend in place and the strength of the trend. In this example the line is rising up sharply indicating a strong trend.

More than one trend line can be drawn to show if a trend is getting stronger, weaker or staying the same.

Trend lines can also be completely horizontal between two identical price points. This can clearly show where price has “bounced” on at least two previous occasions. This can signal strong support or resistance.

Two terms for you now, if there is a low that a price has bounced at twice, this is commonly known as a double bottom. You can probably guess what two highs would be called, a double top.

Technical Indicators

There are many technical indicators that can be used by technical traders. Many of them aim to tell you when the market is overbought and oversold. Commonly used indicators include the relative strength index, MACD and the stochastic oscillator. These indicators all use different formulas to calculate their readings.

Many technical traders use a combination of the instruments talked about above to identify support/resistance point and to identify trends.