How To Do Technical Analysis Of Stocks

Research has an important role in the success of a business. It helps us to make evidence based assumptions about the actions needed to get the best results.

Trading is a serious business. It exposes your hard earned money to market risks. It is of utmost importance that you risk your money in trading after you do the necessary homework in the form of research.

Jumping into the financial markets without adequate analysis is like moving in a dark tunnel without a torch. You will keep wandering here and there without any proper direction and losing your way out. It can lead to losses piling up and ultimately blowing your trading account.

Technical analysis is a charts and tools based research which gives us better entry and exit from a trade in various financial securities.

Learning has an important role on the path to be a successful trader. Technical analysis can be employed to any security like stocks, forex, commodities and it works same for all of them.

In this article, we shall be talking about stocks only and you will learn stock technical analysis, various technical analysis tools and how to analyse a stock!

Introduction To Technical Analysis

Technical analysis is the process of studying past trading data of a security in the form of technical charts using various tools to predict the future price action of that security for taking trading decisions.

Traders use technical analysis of stocks to find appropriate entry and exit prices from a trade. Reading past trading data shows at what price level the stock was taking support or finding resistance in the past.

Entering a stock near a support and exiting near resistance price level minimizes the risk potential and maximizes the profit potential.

Technical analysis is based on three assumptions:-

• History repeats itself  –  This is based on the logic that the security prices have a memory for the past action. Hence, a security behaving at a particular price level is expected to behave similarly in future. This is the basis for securities facing resistance or support at certain levels repeatedly. 
• Markets discount everything  – It states that any event likely to affect security prices is already factored in the current price. In simple terms, markets know everything.
• Price of a stock continues to move in a trend until the trend is changed. Technical trader attempt to ride those trends using technical analysis of stocks.

Stock research using technical analysis is ideal for short term trading decisions. Short term time frame can be for a few minutes as in intraday trading or few days to few weeks as in swing trading or positional trading.

For investing in stocks for long time frames, fundamental analysis is preferred for stock research.

Fundamental analysis involves studying the fundamentals of the company like balance sheets, liquid assets or loans, earnings reports, ratios like price to earnings ratio, profits earned or dividend payouts to take an investment decision in the stock.

There are investors who use fundamental and technical analysis to buy stocks. Fundamental analysis is used to find a value stock and the technical analysis to make entry into that stock at an appropriate price level.

Getting Started In Technical Analysis

Reading stock charts looks like a cumbersome task initially. However, as you do it regularly, it becomes very easy and does not take much time to read charts once you develop a system.

You need certain tools for getting started in technical analysis for stocks. These tools guide us about how the stock prices are behaving currently or behaved in the past. Based on that data, we can make a prediction about the future course of action for that stock.

Technical Analysis Tools

The different types of technical analysis tools deployed to analyse a stock are the technical charts, the chart patterns, technical indicators, oscillators, moving averages, trendlines and Fibonacci retracement lines.

We have to use a combination of these tools to find signals for stock trading.

Software For Technical Analysis

A charting software lets us study the stock charts. It has all the available tools for analysing stocks. You can get a free software for technical analysis from the broker where you open a trading account.

There are some good websites which provide all the tools for stock analysis as provided by those software. The most popular are the Tradingview and Investing.com. Premium technical analysis software like Metastock or Ninjatrader are good options if you can afford to buy.

Technical Charts

The technical charts represent the past price action data of stocks graphically. Different types of technical charts in technical analysis are the line charts, mountain charts, OHLC charts, heiken ashi charts and candlestick charts.

Out of them, OHLC and candlestick charts are very popular amongst the traders around the globe. The reason being the important information these charts yield.

OHLC stands for open, high, low and close. Both OHLC and candlestick charts give same information, candlestick charts being more visually appealing.

Candlestick Chart in Technical Analysis

A candlestick chart in technical analysis gives us the deeper insights about the price action of a stock. Apart from showing us the open, high, low and closing price, the candlestick chart reveals the whole traders’ psychology.

Each candlestick in the chart gives us valuable information for stock price for any particular time period. There are so many popular candlestick patterns widely used for stock analysis.

Some of these patterns are single candlestick pattern while others are multiple candlestick patterns. It is extremely important that you learn the candlestick patterns well to find reliable buy and sell signals.

Technical Chart Patterns

Markets and stock prices do not move in a straight line. The prices keep oscillating higher and lower while following a particular trend.

These moves or consolidations lead to formation of certain patterns on technical charts, known as technical chart patterns. These patterns are expected to determine the next move in stock prices.

The popular technical chart patterns are the triangle patterns, wedge patterns, channels, head and shoulders pattern, inverse head and shoulders pattern, flags, pennants, double tops, double bottoms and cup and handle patterns.

Some of them are bullish patterns while others are bearish patterns. Some are trend reversal patterns while others are continuation patterns.

Although, there is no certainty that the targets projected by these patterns will be definitely seen in future but still they are seen by majority of the traders and it is really important that you learn to identify and trade them.

Technical Indicators

Technical indicators are the technical tools to complement the technical charts. Although a simple candlestick chart gives enough information about the stock price behaviour, adding technical indicators to the charts yields much more information.

Vast variety of technical indicators are available for technical analysis but the important and popular ones are the moving average convergence divergence (MACD), moving averages, ADX, bollinger bands.

Technical Oscillators

Technical oscillators are the technical indicators whose value oscillates between a range. The oscillators tells us about the overbought or oversold stocks.

The oversold level gives us a buy signal while overbought level gives us a profit booking or short selling signal provided the other chart structures and indicators support this view.

The important and most widely used technical oscillators are the relative strength index (RSI), stochastics and momentum oscillator.

You can find multiple indicators or oscillators in your technical analysis software but it is advisable to stick to only two or three widely used indicators. Keep things simple as far as possible. Adding complex indicators are not going to help you much.

Moving Average Technical Analysis

Moving averages are the oldest and still widely used indicators for stock research for trading or investing in stocks. They are the most simple tool you can deploy to your trading system.

Depending upon the formula to calculate moving avaerage, it can be simple moving average (SMA) or exponential moving average (EMA).

On the basis of time periods taken to calculate moving average, it can be 5, 10, 20, 21, 30, 50, 100, 200 or 250 period moving average. Short periods like 5, 10, 20 or 21 are ideal for EMA while long periods are suitable for SMA.

We shall not be going into further details of moving averages here but you should definitely deploy them to take trading decisions with confidence.

Fibonacci Technical Analysis

Fibonacci are also one of the important and widely used technical analysis tools. It is based on the pull backs made by the stocks after a move in stock prices.

Fibonacci retracements are the retracement lines a stock is expected to pull back to after a move in one direction. The retracements correspond to 38.2%, 61.8%, 76.4%, 85.4%, 91.0%, 94.4% and 100%.

The Fibonacci retracement technical analysis is done by joining the recent high and low made by a stock. Your technical analysis software creates the retracement lines at the above mentioned levels.

A stock moving higher is expected to pullback to 38.2 or 61.8% retracement lines in case of price correction or profit booking. While 38.2% retracement is not much reliable, 61.8% retracement is known as golden ratio.

Stocks taking support at 61.8% retracement are expected to assume the uptrend in case of upmoving stocks and this level offers very good entry point for trading purposes. The lower retracement line makes your stop loss price.

Trendline Technical Analysis

A trendline makes an important tool in the arsenal of a technical analyst. Trendlines are made by joining the lows or highs made by stock prices over a period of time.

Trendlines made by joining the lows of stock prices act as support for future price action. Trendlines made by joining highs act as the resistance for future price action.

Sloping trendlines are preferable for taking buy or sell signals for stock trading rather than horizontal trendlines. However, too much steeply sloping trendlines should be avoided.

A stock moving above a trendline is expected to continue the existing trend and offers a good entry point when prices pull back to this trendline. They give you a very good dynamic trailing stop loss which keeps on moving along with the trendline.

How To Analyse A Stock

Now that we have talked about different technical analysis tools needed to analyse a stock, lets move on to how to analyse stocks. You have to build a trading system based on these tools to find eligible stocks for trading or investing.

We can use different methods like fundamental analysis, technical analysis, delivery buying or open interest analysis for stock analysis. This is purely depending upon our time frame or our own discretion.

There are traders and investors who use the combination of all of them to filter out the best stocks for their trading or investing decisions.

We shall be talking about technical analysis only to know how to analyse stocks in this article.

As we talked above that simple the process we keep the better it is for us. Although we can use plenty of technical indicators for stock technical analysis but we shall be keeping ourselves limited to maximum of 4 or 5 indicators to find the appropriate stocks for trading.

Steps to technical analysis of stocks :

1. Use a candlestick chart without any technical indicator and look at the bigger picture. You can easily spot if the stock is in an uptrend, downtrend or sideways movement. You would avoid stocks in downtrend unless you are a short seller. Short selling is for professional and skilled traders and you should avoid it.
2. Draw different moving averages over this chart to find out the short term, medium term and long term trends in stock prices. Stocks above 200 sma are in long term uptrend, above 50 day sma in medium term uptrend and above 10 or 20 EMA in short term uptrend.
3. Find out if the stock is taking support at any important moving average with the formation of important short term candlestick patterns or medium or long term chart patterns.
4. If you find stock taking support at a moving average, draw commonly used indicators like MACD, RSI or stochastics to find out if these indicators support the buying interest in a stock. If yes, you can look to buy stocks near those levels.
5. Sometimes stocks are away from moving averages due continuous price rise in bull market. Use Fibonacci retracements in that scenario to find entry points near 38.2% or 61.8% retracement lines in expectation of prior trend resuming.
6. Other than the above techniques, you can start joining lows or highs to draw a trendline. The more the troughs or peaks touching a trendline, the stronger it is. A stock taking support at a trendline supported by favorable technical indicators offers reliable trading opportunities.

The process of technical analysis does not end here but still these steps can offer you multiple trading opportunities for stock trading. You must remember that technical analysis is not 100% error proof.

No matter how much expertise you achieve in analysing stocks, you can not get 100% winning rate in stock trading. Being profitable in trading stocks does not depend entirely upon how well you study technical charts but on proper position sizing and risk management.