As featured in the Herald Sun – Friday 28th October 2016.
By David McCulloch – Market educator and consultant to Share Wealth Systems
Many traders base their decisions to enter the markets using technical analysis. This involves the study of price over a period of time. Price movements occur because there is a differential or imbalance between demand and supply in the market. For every buyer there must be a seller, and for every seller there must be a buyer. So in reality it is the buying “pressure” creating what we call demand, and selling “pressure” that we call supply. The change in price due to these pressure is what a technical analyst studies. Price movements over a period of time are observed and patterns of price movement recorded. Identifying patterns and the likelihood of those patterns repeating in the future is a core component of a trader’s methodology.
The trader (an investor with a plan) using technical analysis understands that the current price of a stock is the result of all the known information about that stock. The information that drives a stock price is fundamental in nature, and is used by fund managers and fundamental analysts to determine a fair price or valuation. These huge market participants (aka Elephants) create demand or supply on the basis of their fundamental research, which helps them to produce a stock valuation. The market is the perfect place to observe all the “opinions” of the bigger players, and we get to see this through changes in demand and supply and ultimately price. If prices trend higher over a period of time, it is a fair assumption that the bigger players have a positive collective view of the stock, and that view is also likely to be supported when examining the stock’s price on a chart.
The stock chart is main tool that a technician will use to perform their analysis. The data on a chart can be used in many different ways, and has led to the creation of a huge array of data driven technical indicators, and last week we looked at moving averages as a trend following indicator. The Direction Movement Indicator (ADX group) is another useful tool to help traders identify a strong trend – either bullish or bearish. “What defines a strong uptrend”? There are a number of perspectives on that, but generally an ADX rating above 25 suggests that a trend is now gaining momentum and it’s more likely to continue into the future
The use of indicators makes it possible to anticipate the future direction of a share price’s movement however no single indicator will be right all the time. Technical analysts will often use several indicators at once, looking for confirmation or alignment. This provides a trader with a degree of confidence in placing a trade. Learning technical analysis is easily achievable for anyone, you just need to learn how to read between the lines, and importantly keep the interpretation simple.
David McCulloch is a market educator and consultant to Share Wealth Systems.