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Last updated: July 2020

Young Investors

Introduction of Technical Analysis

Friday, 3 January 2014

For the novices, the stock market is always covered in a veil of mystery. Many who started to invest in the stock market does not know how to pick a “potential” stock, and end up "buying on rumor" leading to losses in the end.

Now, let us learn some basic stock picking techniques! There are two most common method of stock picking: Fundamental Analysis and Technical Analysis.

Technical Analysis is more popular but what is Technical Analysis? Is it that easy to make profit with technical analysis?

In this article will introduce you to Technical Analysis.

Theory of Technical Analysis

Technical analysis, in fact, uses historical data to predict future price movements. It is a “Pure Figure Analysis” technique and ignores the value of the fundamentals. So, the first premise of technical analysis is that price will reflect all the information, including the company's value, Market Trend, Monetary Policy & Fiscal Policy, Macroeconomic Trend, as well as other information. If the stock price is not reflecting information, then technical analysis will lose its effectiveness.

Four major elements of Technical Analysis (Volume, Price, Time and Range)

- Volume is the most important element. If there is no or low Demand Quantity (Buy Volume), it means there is no buyer for the stock. Hence even there is a price increase; it is meaningless because you cannot sell your stock as there is no buyer. This rise in share price is “Book Profit” and is “unrealized”. Only when you are able to sell your stock and get back the cash then the profit is real or “Realized Profit”.

- Price. Like volume, there must be changes in the price. If the volume increases, while prices remained in place, it is no profit!

- Timing. If buy stocks at the wrong timing, most probably you would be “locked” at high price. Timing is the most important element in determining “cash efficiency” and “profit taking”.

- Range, refers “Potential Upside”. Technical analysis is to predict the “potential upside” or “range” that the share price will move to.

Technical analysis is a "chart analysis" use to predict the trend. Technical analysis is basically categorized into three types: 1. Trend, 2. Pattern, 3. Indicators

1. Trends

Use charts to observe long-term, medium-term and short-term price trends to predict future price movements. Trend analysis use line to connect Top and Bottom price to determine "support line" and "resistance line". Support line is a line that connects "low", while resistance line is connected with the high point. In theory, when price touched support line, the price will bounce up, while close to a resistance line, it will fall back down. However, when the price strongly fell below the support line, it will fall even more. Conversely, if break through the resistance line strongly, it will rise sharply.
Trend analysis has no "standard" line-drawing format; the line will vary by person. This is due to the different in chart duration each person is viewing.

2. Pattern

Pattern analysis only used on candle stick chart. It is a kind of observation on Investor Sentiment through the price movement. Each candle has its meaning, and grouping few candle stick together will increase the accuracy in “reading” the market sentiment and also price prediction.

3. Indicator

Indicator is said to be one of the most popular technical analysis. In terms of price sensitivity, it is also more elastic than Trend Line and Pattern analysis. With its flexible and user friendly, demand of technical analysis is gradually rising, its evolution and innovation is also changing every day.

Technical analysis is just mathematical equations that analyze historical data and decide buying (entry point) and selling price (exit point).

Buy and sell signal usually determine by lines cross or index breakthrough.

Things you should know in technical analysis

1. Understand the theory and principles of each technical analysis; know the strengths and weaknesses of each technical analysis.

2. Each technical analysis method has its strength and weaknesses, so it is advisable to use a combination of different technical analysis methods in order to get better results.

3. Technical analysis used "historical" data to predict future, but future is actually “unknown”, do not blindly follow the pace of technical analysis.

4. When the price down drastically without reason, technical analysis will lose its effectiveness. During this time, you need rely on fundamental analysis to determine company value, and trade with “value”. Combine fundamental and technical analysis in order to increase possibility in making profit.

5. “Strong Bull Signal" could be caused by a “Big Player”. Be careful in using technical analysis as it could be a trap and you could lose all your investment.

6. There is no one as rich as Warren Buffett in using the same “Investment Method”. Do not blindly follow others’ methods to do stock trading. Everyone's risk tolerance is different; someone else's method may not suitable for you.

**Charting Tools: BursaStation**

By the Young Investors Team