Technical analysis is the study of share prices. By researching the past performance of a share, we can gain an insight into how it will likely perform in the future.
To fully appreciate the power of technical analysis it is important to understand the basics. There are three key principles upon which technical analysis is based:
Everything is discounted and reflected in market prices.
Prices move in trends and trends persist.
Market action is repetitive.
Let’s examine each principle in detail.
The first and most important principle is that everything is discounted and reflected in market prices. All knowledge, regardless of type (fundamental, political, economical, psychological or other) is already reflected in market prices.
It can be time consuming studying fundamental information such as company financial statements, earnings and P/E ratios in an attempt to determine the potential for a share to rise in value. The real value of a share at any point in time is determined solely by supply and demand, as reflected in trades made at the stock exchange.
Technical analysts do not care what the underlying forces of a shift in supply and demand are; instead he or she is interested in what occurs to the price.
If demand is greater than supply, prices will increase. On the other hand, if supply is greater than demand, prices will decline.
The study of market prices is all that is necessary to make money from the stock market.
The second principle on which technical analysis is based is that prices move in trends and trends persist.
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