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Charles A. Jaffe

Investment Dictionary

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Technical Analysis of Stocks


Technical analysis of stocks is widely known type of stock analysis. Technical analysis is completely opposite to fundamental analysis. While fundamental analysis relies on company’s ability to generate cash flow and pay dividends including growth, technical analysis does not even look at company’s financial data or any financial ratios


Data used by technical analysis:

- Historical stock price (charts) including opening and closing prices, min max prices and other.

- Trading volume

- Open interest


Not many investors believe in technical analysis while most of the investors are skeptic about the efficiency of such analysis method which relies only on trading data and no real fundamentals. There is no empirical evidence that technical analysis really works and such type analysis could be compared more to “spells” than to real analysis. 


However, there are still mass of personal investors and institutions that treat technical analysis very seriously. Even many books are written on this theme. So, why technical analysis is so popular? It is normal question, of course, and there are many answers to this one. Let’s first look at the main reason which as always is money. Technical analysis users usually are more stock traders than investors and such traders pay the best trading fees for brokerage companies, or in other words, they are the most valuable clients for investment industry because they feed investment companies. So, it is natural that speculating in stocks is promoted as much as FOREX trading which is similar speculation where technical analysis is used too. People go where money goes.


One may think that people would resist to marketing and would not use any tools that are created to increase speculating rate. Maybe it is true. But another true is that people are just human beings strongly affected by emotions. It is scientifically proved that people are tending to remember positive memories better than negative ones. Also, another factor that disturbs the evidence of technical analysis is market trend which may let receive some earnings for technical traders. And one another thing: an ancient inheritance of human kind which is mysticism. Some people are attracted to it more others less, while technical analysis may have a lot in common with oracles and mysticism.  


But can technical analysis still work under some conditions? It is possible as long as many investors are using such instruments. For example, such very widely known indicators as head-and-shoulders or double-bottoms may really have some true in it because mass of people know them. If a lot of investors apply such indicator, then they have real effect to the market. Just imagine the situation, when thousands of investors see some shoulders that signal the fall in stock price, what they will do? They will sell the stocks, and of course, the signal will become correct…


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