Everyone has seen those advertisements with professional stock traders looking at their computer screens with graphs of stock prices going up and down. It is probably the first time we are introduced to technical stock trading. Technical stock analysts simply study market price action and try to predict the future prices of stocks using the past prices.
Technical analysis borrows from the Dow Theory, which had three underlying assumptions.
1. Market Action Discounts Everything
Technical stock analysis assumes that the price that one sees on their trading charts is the one and only price that matters. This means that whatever price one sees in a stockbroker’s platform, has factored in all the reasons that the price can go up or down. Even if there is bad fundamental information about a particular company, the present price is the one true price.
This allows the technical stock trader to avoid any fundamental data or any news that is coming out about a stock.
2. Stock Prices move in Trends
Technical stock traders believe that prices move in patterns and trends. A trend is basically the general direction that a stock price is taking. The assumption is that once a stock price starts moving up, it will generally continue in that direction until something stops this.
Technical analysts make their money by identifying trends and market patterns. There might be minor trends and major trends in any price movement and it is the work of a technical analyst to identify them.
3. Historical Stock Price Actions repeat themselves
Technical traders believe that price action will tend to repeat itself just as humans are tend to do the same thing over and over especially if it is profitable. The idea behind this is very simple, technical traders look at the history of prices and see how traders traded at those prices. They assume that traders will do the same thing when prices reach the same levels.
That is the main reason why technical traders tend to use charts where they have the various tools to identify price action. Charts used to be drawn by hand by early technical traders but technology has made it easier to use them on computers. Some of the charts are so advanced that traders can trade on them automatically without human interference.
It has taken a long time for technical analysis to be accepted as a good way to pick good stocks. However, major banks and financial institutions now have departments where technical analysts spend their time picking stocks using these tools. Individual traders are also getting involved and are slowly catching up to the need to learn such technical analysis tools like support and resistance lines, moving averages, and Fibonacci numbers.