What Is Technical Analysis in the Stock Market?

Technical analysis is a trading discipline that focuses on evaluating investments and identifying potential trading opportunities by analyzing statistical trends gathered from trading activity such as price movement and volume. While fundamental analysis evaluates a security's value based on business results such as sales and earnings, technical analysis focuses on the study of price and volume.

This method uses various charting tools to generate trading signals, but it can also improve the evaluation of a security's strength or weakness relative to the broader market or one of its sectors. Technical analysis can generally be applied to any security with historical trading data, including stocks, futures, commodities, fixed-income, currencies, and other securities.

How to Use Technical Analysis

Professional analysts often use technical analysis in conjunction with other forms of research. Retail traders may make decisions based solely on the price charts of a security and similar statistics. Still, practicing equity analysts rarely limit their research to fundamental or technical analysis alone.

Some commonly used technical indicators and charting patterns include trendlines, channels, moving averages, and momentum indicators. Technical analysts look at the following broad types of indicators: price trends, chart patterns, volume and momentum indicators, oscillators, moving averages, and possible support and resistance levels.

The core assumption of technical analysis is that all known fundamentals are factored into price; thus, it's unnecessary to closely monitor these fundamentals. Technical analysts do not attempt to measure a security's intrinsic value but instead use stock charts to identify patterns and trends that might suggest what the security will do in the future.

Technical Analysis vs. Fundamental Analysis

Fundamental analysis involves analyzing a company's financial statements to determine the fair value of the business, while technical analysis assumes that a security's price already reflects all publicly available information and instead focuses on the statistical analysis of price movements.

While some analysts and academic researchers expect that historical price and volume data do not contain any actionable information, neither should business fundamentals provide any actionable information. These points of view are known as the weak form and semi-strong form of the Efficient Markets Hypothesis (EMH).

Universal Technical Analysis Indicators

Technical analysts have developed hundreds of patterns and signals to support technical analysis trading. Some indicators are focused primarily on identifying the current market trend, including possible support and resistance areas, while others are focused on evaluating the strength of a trend and the likelihood of its continuation.

Commonly used technical indicators and charting patterns include:

Trendlines: A trendline is a tool used by many traders and analysts to visually represent the direction and speed of price movements in financial securities. By connecting pivot highs or lows, it helps identify trends and forecast future price movements. Trendlines can be applied to different time frames and intervals, making them widely applicable and useful for technical analysis.

KDJ: KDJ is a widely used technical indicator that reflects the strength of price movements and generates overbought/oversold and trading signals in short-term trend analysis for futures and stock markets.

OSC: An oscillator is a tool used in technical analysis that creates trend indicators bounded by high and low bands. Traders use oscillators to help determine short-term potentially overbought or oversold market conditions. Oscillators are most effective when combined with other technical indicators, particularly in sideways markets.

RSI: The Relative Strength Index (RSI) is a technical indicator used in stock trading to measure momentum based on closing prices. It is displayed as an oscillator between 0 and 100, with values above 70 indicating overbought conditions and values below 30 indicating oversold conditions. Developed by J. Welles Wilder Jr., the RSI is commonly used by investors to assist in determining whether a stock may be undervalued or overvalued.

MA: Moving Average (MA) is technical analysis tool in finance that helps to smooth out price data by creating a constantly updated average price. It is a trend-following or lagging indicator based on past prices and comes in two types: Simple Moving Average (SMA) and Exponential Moving Average (EMA).

BOLL: Bollinger Bands offers insights into price and volatility. Created by John Bollinger in the 1980s, the bands help traders determine entry and exit points for trades, identify overbought and oversold market conditions, and monitor for potential breakouts. This simple trading tool is widely used with both professional and at-home traders in multiple markets.

MACD: The Moving Average Convergence Divergence (MACD) is a technical analysis indicator that monitors the relationship between two moving averages and identifies trend changes in the price of a security. It employs a signal line to try to confirm the strength of a trend, making it a widely used tool among traders.

The Moomoo APP provides all the technical indicators mentioned above and comes with a convenient drawing tool for you to use, giving you the opportunity to become more confident in your investment journey.

Possible Advantages and Limitations of Technical Analysis

One of the most significant potential benefits of technical analysis is its ability to help identify trends in the market, providing insight into whether they are bullish, bearish, or otherwise.

Additionally, technical analysis provides entry and exit signals, which allows investors to better identify when to enter and exit trades. This can be especially useful in trying to mitigate risk. Furthermore, technical analysis is based on objective data and mathematical calculations, providing a clear approach to analyzing securities.

However, there are also limitations to using technical analysis. One disadvantage is that it can be subjective and may give conflicting signals, particularly when used in isolation. Technical analysis is also based only on price and volume data, meaning it may not consider fundamental factors that could have a significant impact on a security's value.

Additionally, technical analysis may not work in all types of market conditions and may give false signals. Finally, using technical analysis effectively may require some skill and experience, making it difficult for new traders to use. Despite these limitations, technical analysis remains a widely used tool among investors for assessing investments trade prospects by examining statistical trends collected from trading activity.