Investing techniques basics – technical analysis

Most of the investment analysts talk about analysing the various investing options, not about their methods. But in reality they are very specialised on what they are doing: SeekingAlpha.com for example is looking mostly for the fundamental analysis of the stock markets, whereas Prophet.net is considered by Forbex the apex of the stocks technical analysis.

But what are these mysterious terms reffering to exactly? And how can a certain type of analysis help you in your investing?

By definition, technical analysis is essentially the search for recurrent and predictable patters in stock trading. Although the technical analysts admit that the future information might be useful for the prospects of a firm, they consider that such infoamtion is not 100% required to create a successful trading strategy. The fundamental belief behind the investments technical analysis is that if the stock price responds slowly enough, the analyst will be able to identify a trend that can be exploited in a further adjustment period. Therefore the key to the technical investing analysist is the concept that the demand-and-supply processes from a stock exchange have a slack, a delay in what they represent.

You can notice how these fundamental beliefs from the technical analysts work by your own reflection on their work. For example, we at doitinvest.com have discovered that the delay in the internet quotes of shares and their actually trading prices are not so important for a technical analyst, who can actually plot them on the trend and try to realize a profit by simply extrapolating a further future level of that quote.

The technical analysts are ofted called “chartists” since they study records or charts of past stock prices in order to discover profit-making profits. A classical example of technical analysis is the “relative strength” approach. The chartists compare the performance of one share over a period with the performance of the market or other shares in the same industry.

One of the most utilised components of the technical analysis is the notion of resistance levels or support levels. These values are said to be price levels above which stocks have difficulties to rise, or under which they will hardly fall. Resistance levels are rather determined by the market psychology rather than by anything else. A good example is the stock of Microsoft, which in the last 52 weeks has raised as high as $37,5. Currently the Microsoft stock is valued at $23,92, and if the stock would rise to $37,5, many shareholders would sell the stock in order to marke their profits, making it impossible to raise above that level.

In a theoretically efficient market, the efficient market hypothesis makes technical analysis invalid. The past history of prices adn the trading volumes are publicly available at a minimal cost, making any information from the past transactions already built into the stock price. As most of the investors have the best knowledge of the price history, they drive the prices at the levels where the expected rates of return correlate perfectly with the shares risk. At those levels no investor can expect abnormal returns, or returns higher than the “normal” ones. (or lower).

Pattern prices should be self destructing, in that if a trader discovers a profitable pattern in a stock price, by trading them he/she actually brings the prices again at normal levels (through the game between offer and demand). The validity of the rule can only be tested if it becomes reflected in the future share prices, therefore the technical analysis tends quite often to become a self-fulfilling prophecy.

Another interesting application of the technical analysis of the self-fulfilling prophcies is the market manipulation of small stocks. This was again noticed in a past blog by www.doitinvest.com… Since the small stocks have small trading volumes, it is relatively easy to influence their prices upwards by buying a relatively small volume of those shares. After there lapsed a reasonable amount of time and the small stock has reached a certain level (higher than the normal one), the announcement that this stock will continue to raise is pushed to the markets through publicity on a stock alert. The stock alert shows an otherwise correct technical analysis, which extrapolates (falsely) that the upward price trend will continue, thus pushing many more investors to buy the small stock. Of course, after a modest rise the information-pusher sells the stocks making a nice profit, leaving the investors with overvalued stocks(overvalued because they were pushed up by over-buying and not by the actual economical prospects of the company).

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