Is Technical Analysis voodoo?
Contrary to what some people think, Technical Analysis is not a kind of black magic or sorcery. Also, the use of technical analysis does not increase as we get closer to Halloween.
It is important to keep an open mind and realize that things such as trend lines, triangles, and other patterns actually do work. If you analyze past data, you will see that price and economic movements tend to repeat themselves.
Why do trends or patterns even form on charts?
Charts show the collective opinions of all market participants for that day, or month, or whatever your timeframe may be.
Charts are direct evidence of the market’s beliefs and feelings, and each movement reflects a bit of human emotion. Therefore, since humans are creatures of habit, it’s no surprise that patterns repeat themselves over and over, and this has been true since charts were first invented.
Identify the difference between Uptrends and Downtrends
In the diagram above, we can see a typical up trend and down trend. I’m sure you’ve seen these zigzags before, but why do they form? Let’s say someone bought a stock at a certain point. If that stock went up, but pulled back to the original purchase price, they will often think that it’s an opportunity to buy more at their original price, thus adding to their position.
This is also the same for shorts when they are able to short a stock at the same price they shorted previously. Then why do peaks form? People sell (or cover) to take profits. Obviously, any increase in selling will pull the stock back. Those who bought at a lower level may start buying again. This repeats and repeats until:
1) There is no more stock left for people to buy, or
2) There is too much supply and not enough buyers.
On a larger scale, this is how bull and bear markets begin and end.
Some basic chart patterns
- Trends & Trend lines
- Support & Resistance
- Neutral Ranges
- Triangles (symmetrical, ascending, descending)
- Double tops & bottoms
- Head & Shoulders
- Cup with Handle