Technical analysis is like playing chess. You see the end of the game once you make the right investment decision. A winning portfolio is essential for you to make profits. Thus, conducting a technical analysis will give you an upper hand in deciding to buy, sell, or hold a stock.
Why Technical Analysis?
Technical analysis provides a graphical analysis of the behavior of a stock or market index. Data generated from the market includes:
- The momentum of prices for a span of time
- Turning points prices in the past, and future
- The volume of stocks bought and sold every day.
- Technical analysis primarily tracks the actions of large institutional investors. The size of their transactions allows more visibility.
A stock market investment decision can be risky. Why? Because the investor has no idea when the market may fluctuate. By using technical analysis tools, investors have a better chance to predict the future stock price movements.
Conducting a technical analysis helps stock investors to identify:
- Instabilities of particular stocks either in the past or present
- Historical trading levels and volumes of different stocks
- Stock’s value and ability compared to the whole stock market
- The effects of important events on stock value and price fluctuations
- Resistant and support levels in the market
- The best time to enter the market
Before entering or exiting a stock market, you should first understand technical indicators. Technical indicators are calculations applied to a stock’s past prices, volumes or patterns. They help to alert investors of stock trends and predict the direction of future prices.
Technical indicators can either be leading or lagging. The former informs investors when a trend is about to start, and the latter follows the price action. Some of these technical indicators include Momentum indicators, Volume indicators, Trend Indicator, Volatility indicators.
- Trend Indicator: These indicators measure the strength and direction of a trend. It uses averaging price mechanism to establish a baseline. When the prices move above the average that is considered an upward trend. Vice versa is a downward trend. Moving averages, moving average convergence divergence, parabolic stop and reverse are the most popular indicators.
- Momentum indicators. These indicators act as a guide in identifying the speed of price movements. The mechanism used is the calculation of current and previous closing prices. Stochastic oscillators, commodity channel index, and relative strength index are the most popular indicators.
- Volatility indicators. These indicators measure the rates of price movements irrespective of the direction. The mechanism used is the consideration of the lowest and highest historical prices. Bollinger bands, true average range, and standard deviation are the most popular indicators.
- Volume indicators. These indicators confirm or measure the strength of a trading trend. It is based on smoothing or averaging of raw volumes. Large price movements are usually influenced by trading volume increase. Chaikin oscillator, on-balance volume, and volume rate of change are the most popular indicators.
Learn About the Stock Market
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The stock market brings together investors who buy and sell shares of the traded company. The stock market is not comparable to gambling as some people may suggest. The stock market is unlike gambling where you lose all the money put on the table. In the stock market, you can only gain and lose part of your invested money. To make profits, you need to understand some stock market basics. The interplay of demand and supply means that one investor will lose while the other gains. Thus, it is paramount to be on the gaining side.
Licensed brokers or brokerage firms facilitate buying and selling of stocks. The mechanisms involved in buying and selling is uniform whether handled by a broker or a firm. The basics involved in the stock market include:
To start a stock sale or purchase, a quote is first obtained. The quote details the current bid, price offer and the last traded price. A bid is the highest price an investor is willing to pay for a stock. The offer is the lowest price at which someone is willing to sell a stock. For a trade to be initiated, the price offer and the bid should coincide. Interested buyers usually make a bid, and a stock seller makes an offer. Stock quotations also include data on trading volumes. Volume of sales is vital in technical analysis. Ticker symbols are used to represent a company’s stock, e.g. CAT for Caterpillar Inc.
Types of Stock Trade
There are many types of stock trades. The two most common are market orders and limit orders. A market order instructs brokers to sell or buy stocks at the best available prices. Limit orders specify the maximum price the person is willing to pay for a stock or the minimum price the person is willing to sell a stock. If an investor wants to buy 50 shares of CAT at the market, and the quote indicates: Bid: $109.2 (50), Offer: $110.0 (25), Last: $110.5 (125). Then it means that the last trade was 125 shares at $110.5 and it indicates 25 shares are offered at $110.0. Suppose another 100 shares are offered at $111.4. The market order would buy the 25 shares at $110.0 and then buy 25 more at the next best price at $111.40. Once an order is complete, it is considered filled. Under the limit order, an investor will buy 25 CAT shares at $110.0 and wait for a seller to come down to his price.
Stop prices are used to activate a trade when the price of a stock reaches a particular price. For example, assume that an investor owns stock XXX, which is currently trading at $15. He places a stop order to sell it at $10. The order can only be filled once and if the stocks drop below $10. This is a good mechanism to limit losses. So, stop orders can be used to guarantee profits. For example, assume you bought stock TTT at $5 per share. Currently the stock is trading at $12 per share. Placing a stop order at $9 guarantees a profit of $3 per share.
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