Technical Analysis 101

I have started reading a bit about Technical Analysis once again, and here I would note down all the important points so that I do not have to get back at the bulky books again and again for future reference.

Introduction

Technical Analysis is the study of patterns – price, volume or any other variable. And it is based on a few fundamental principals:

1. Everything is discounted and reflected in the market prices: All the knowledge about the specifics of the company and sector has been captured by the prices, and any movement is purely based on supply and demand of its stocks. Here, it implicitly differentiates between the underlying company (real world) and its stock. The stock price moves purely as a function of its demand and supply. In other words, Price is King.
2. Prices move in trends and trends persist: It means here that there is a trend in motion due to interplay between demand and supply. And once the trend is set, it continues for some time unless there is a clear reversal. It assumes here that not all people react at the same time, and hence once there is buying in a stock, it would go on for some time. As they say, ‘Trend is your Friend’.
3. Market Action is Repetitive: Certain patterns appear time and again on the charts, and it means that people behave in the same way as they have in the past. People react similarly in similar situations, and this can lead to identify major tops and bottoms.

Basics of Charting

The most important indicators are related to price, volume and open interest. While tracking prices, one should keep in mind that there are usually 4 prices which are important – Open, Close, High and Low (for each period). In terms of volume and open interest, they are usually read in conjunction with the price action, and independently do not signify anything.

Important Chart Patterns

1. Reversal Patterns
   • Head and Shoulders Pattern
   • Ascending and Descending Triangles
   • Rectangles
   • Double and Triple Tops/Bottoms
   • Rising and Falling Wedges
2. Consolidation Patterns
   • Flags
   • Pennants (Triangles)
   • Symmetric Triangles
   • Head and Shoulders Continuation Patterns
3. Gaps
   • Breakaway Gap
   • Runaway Gap
   • Exhaustion Gap
   • Island Reversal