MASTERCLASS Investing – Financial Health Part 4 – What is Technical Analysis + how does it work?

Financial Health Part 4 – What is Technical Analysis + how does it work?

Today we have Part 4 of our Company Financial Health Series – What is Technical Analysis

In Part 1 we looked at how to determine financially healthy companies to invest in.

In Part 2 we looked at how share investors can tend to fall into 2 groups – fundamental analysis and technical analysis, and explained what is the difference between them – our experience is that both fundamental and technical, can help for increased share-market investment success. 

In Part 3 we looked in detail on what is.

In this final Part 4, we look in detail about Technical Analysis.

Technical analysis

This analysis involves using technical tools to chart the upward or downward movement of a stock’s share price. This is done in order to anticipate and prepare investors for potential positive or negative price actions, and to make informed decisions about buying or selling stocks based on patterns and volume data.

The practice of technical analysis is based on the belief that a security’s past trading activity and price changes are better indicators of its future price movements than its intrinsic value. It originated from Dow Theory, which asserts that market price incorporates all factors influencing a security’s price and that price movements follow identifiable patterns and trends.

Technical Analysis – How it is used

Technical analysis is used to forecast the future price movements of various tradable instruments, including stocks, bonds, futures, and currency prices. It involves studying supply and demand forces as reflected in market price movements, with a focus on price changes and sometimes other factors like trading volume or open interest figures.

Numerous technical indicators have been developed over the years to predict future price movements accurately. These indicators range from identifying current market trends to assessing trend strength and the likelihood of its continuation. Commonly used technical indicators include trendlines, moving averages, and momentum indicators like the moving average convergence divergence (MACD) indicator.

Technical analysis applies these technical indicators to charts of different timeframes, ranging from short-term charts like one-minute or hourly timeframes to longer-term charts like daily, weekly, or monthly ones.

By example, here is a chart of an Australian stock BHP, share price (jaggered) with 2 indicators, Moving averages of 25 and 50 days smooth lines), volume at the bottom, and the opening and close prices can be found with the mouse anywhere on the chart.

Assumptions

One key assumption of technical analysis is that market price accurately reflects all available information about a security at any given time, representing its true fair value. Another assumption is that price changes are not random, leading to the belief that market trends can be identified and used to profit from investing according to the existing trend.

Want to learn the core issues of share investing?

See our slides SMSF & Shares Overview to get a quick session where you can learn to easily understand Company Financial Statements, how to find healthy companies, what Tools and Ratios to use, work on examples and also includes how to get better investment outcomes.

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