For people who are interested in trading stock, there are always ample bullish and bearish signs that were overlooked in retrospect. The methods used to analyze stock trading in general fall into two categories: fundamental analysis and technical analysis. Fundamental analysis focuses on the real value of a company. In contrast, technical analysis only cares about the price and volume movements of the security in the market.
Technical analysis is based on three assumptions: The market discounts everything; Price moves in trends; History tends to repeat itself. The assumption that is most difficult to understand is the first one, which literally means that technical analysis is most important since every relevant factor will be absorbed by the market force. Therefore, after we analyze the prices and volumes of the stock market, we have taken care of everything including the fundamentals.
Another important notion in technical analysis is that price is preceded by volume. Therefore, special attention needs to be directed to daily trading volume as a whole and of the specific security.
The next step is support and resistance analysis. The support and resistance levels are important in terms of market psychology and supply and demand. Support levels are the levels at which a lot of traders are willing to buy the security; whereas resistance levels are the levels at which a lot of traders are willing to sell it.
There are three types of trend: uptrend, downtrend and horizontal trend. Charts are important tools for trend analyses. There are three basic charts: line, bar and candlestick. The first two are easier to comprehend since they are frequently encountered in daily life. The candlestick chart is a little more complicated. The candlestick is comprised of two parts, the body and the shadows. The body encompasses the open and closing prices for the trading session. The body is black if the security closed below the open, and white if the close was higher than the open for the period. The candlestick shadow encompasses the intra-period high and low.
When you are reading charts, you have to be able to recognize chart patterns. There are numerous patterns. The head-and-shoulders pattern, and also the inverse head-and shoulders pattern, is one of the most popular chart patterns in technical analysis. The pattern looks like a head with two shoulders in the chart. Head and shoulders is a reversal pattern that signals the security is likely to move against the previous trend.
Moving averages are another popular and easy to use tool available to technical analyses. The two most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). A SMA is formed by computing the average price of a security over a specified number of periods. Most moving averages are created using the closing price.
At last, when we are interpreting the moving averages, we will look for indicators and oscillators, for instance, the well known indicator Moving Average Convergence Divergence (MACD). MACD is plotted by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero. The most popular formula for a standard MACD is the difference between a security’s 26-day and 12-day EMAs.
Do you follow me so far? It has increased in complexity by now. You might find it is not easy to master technical analyses at this moment. So don’t get too technical. Some of these analyses should be left to experts. For lay persons, although market discounts everything, fundamentals are still easier to gather and comprehend provided that everyone is telling the truth. Regrettably, truth is a scarcity in the stock market and in financial leverages.
The most recent Goldman Sachs scandal bears witness to this statement. Allegedly, John Paulson and his hedge fund, after identifying a raft of bonds tied to the sub-prime home loans, asked Goldman to construct a new security that would allow him to bet against those bonds and cash in if the market collapsed. The now notorious deal with Goldman Sachs is under US Security Exchange Commission’s fraud investigation with charges of deceiving its other security holders.
So, be careful. It is a jungle out here. Do not get too technical. Do not get too fundamental either. And most important of all, trust no one.