Technical analysts use security pricing and trading history to identify the strength and direction of market trends.
The familiar charts and graphs we see in the financial news are examples of the tools technical analysis provides for active security traders to predict future trading patterns.
Assumption: market movements reveal all
Technical analysts do not use any fundamental company information, such as balance sheets or income statements, to make their predictions.
Technical analysis is based on the assumption that every aspect of the market is revealed through market movement.
Prices move in trends, and history repeats itself.
A trend in motion is more likely to continue than to reverse. This gives the technical analyst the ability to make trades on the basis of predicted market trends.
What technical analysts use
Technical analysts use chart indicators to measure past prices, volume, number of issues traded in a day, and price movement trends. Market price is believed to reflect all known information and investor opinions about a security.
Technical Analysis Looks for Trends in the Market
Charts are the foundation of technical analysis.
A consolidation pattern indicates that a trend similar to the previous trend is likely to occur. It can also indicate investor indecision. If security prices rise above a consolidation line, it could indicate a rise in future prices.
A reversal pattern is the opposite of consolidation. A reversal indicates that the next trend to occur will be the opposite of the previous trend. If there was an upward trend, prices could now fall, and vice versa.
Support and resistance
Technical analysts also look at something called support and resistance. Security prices are decided by the negotiation between buyer and seller to reach an agreeable price. A buyer wants to buy low and a seller wants to sell high. Support and resistance measures the degree to which buyers or sellers are winning the price wars.
The support level is the lowest price at which sellers are willing to sell a security. A support level can indicate the price at which a downtrend may reverse itself. The resistance level is the level above which it is difficult for a price to rise. Upward trends may reverse themselves when prices reach the resistance price level.
Technical analysts look for these trends in stock indexes and market indicators, and use them as their basis for making decisions about buying, holding, or selling securities.
This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.
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