Technical chart reading is an alternative form of stock analysis that only a few can make sense of.
BUY stock LMN at Rs 100 with a stop loss of Rs 97 for a target of Rs 109.' If you come across such a recommendation, you are most likely reading a technical call. Like fundamental analysis, a large chunk of market participants also look at technical analysis.
WHAT IS TECHNICAL ANALYSIS?
There is this joke about a dealer whose trades were based on technical calls. One day his boss asks him which stock he is trading on, and he answers 'Ford'. "Great company. In fact own a Ford car," says his boss. "I didn't know they made cars," the technical trader replies.
Unlike fundamental analysis which involves deep research into the economy, the industry and the company, technical analysis is a method of assessing stocks solely on price movements along with volume recorded on the stock exchange. Technical analysis can be employed for analysing any security which is actively traded on bourses. There are analysts who use technicals to recommend commodities, stocks and currencies to their clients. Technical analysis has higher application than fundamental analysis. I use technical analysis to identify a stock, and once I am convinced with it, I look at the fundamentals.
The method does not try and assess the intrinsic value of a security. It does not try and assess the future growth a business can see. But it's based on the assumption that the market prices not only best discount the future prospects of a security, but also give indications of the price movements in future.
THE ASSUMPTIONS
The first assumption is that the market discounts everything. A technical analyst believes that the market price of a stock is the best judge of the underlying value of the stock after taking into account the possible future growth the business can register. It is a consensus arrived at after taking into account the sentiment towards that particular security and the market as a whole, making the best estimate of the value. The second assumption is that trends exist and prices follow trends. The third and most important assumption of a technical analyst is that history repeats itself. Chart patterns repeat irrespective of the securities involved and multiplying or falling prices.
TOOLS
There are many tools developed by technical analysts. One can choose to play the game using various charts and indicators. Charts include bar charts, candlestick charts and line charts. One also look at overlays that are superimposed on the charts, which include moving average, bollinger bands, pivot company, channels. Price based indicators such as relative strength index, stochastic oscillators, average directional index are also used in conjunction with other parameters. Volume made by the security is also considered.
FOR WHOM?
Technical analysis works best for short-term traders and intra-day traders. Those who intend to hedge their positions in market can also use technical analysis. There are few technical analysts who would run after a multibagger opportunity. Most of them eye for a few percentage point gains.
PRE-REQUISITES
Studying price movements is the key to technical analysis. Hence a software is a must. There are many options such as Metastock, Iris and Telecode available in the market. The prices of the software ranges from Rs 25,000 to Rs 1 lakh. But there are many more things required to reach success using this route. Discipline is sacrosanct for a technical analyst. Whatever theory the analyst follows, he has to follow it in totality. It makes more sense if a trader adopts basket approach, where he runs multiple positions in the market. If one adopts basket approach he has to allocate his capital efficiently. At the same time if you have leveraged positions in the market using derivatives, you have to maintain ample cash on hand to pay for margins. In nutshell, money management holds the key.
