Many tools used in stock trading are technical analysis tools, such as charts and graphs, which use historical data to predict future trends. It is known as fundamental analysis.
Other types of technical analysis include candlestick charting (which uses patterns as opposed to moving averages), algorithms (which take into account volume and open interest) and mathematical models (which determine the price elasticity of option premiums).
Technical analysts believe all available information about a company is already factored into its current market price, so they focus on using charts and other tools to identify patterns that may help them predict how stocks will move in the future.
They often rely heavily on historical data when creating their models. Buy-and-hold investors believe this strategy takes too much time and effort, but the truth is that anyone can learn technical analysis. You can try technical analysis in your trading with Saxo.
Moving averages
Moving averages are used to predict support and resistance levels in a stock’s price. They smooth out day-to-day fluctuations, allowing the investor to see the general direction of a stock’s trend.
Candlestick charting
Candlestick charting is one of many charting types that technical analysts use to determine market sentiment and predictive ability. A candlestick consists of:
- A body (which represents the price range during a specified period).
- An upper wick (which represents the highest price traded during that period).
- A lower wick (which represents the lowest price traded during that period).
These tools help traders identify patterns such as key reversals at support/resistance levels or exhaustion gaps.
Algorithms
Algorithms are mathematical formulas that account for volume and open interest when making predictions about a stock’s trending behaviour. For example, algorithms may use the price of options to indicate market sentiment. As demand for a particular option rises, its “intrinsic” value (i.e., in the money) does too. A trading algorithm can store this information and translate it into the reasoning behind price movements over time.
Mathematical models
Mathematical models help traders determine a fair price for a given asset. They do this by determining how much investors would pay for a particular asset based on investor demand, not by looking at underlying value. For example, the price of an asset may be inflated if many people want it, but few can afford it. It would mean that its “fair” price is lower than what the majority are willing to pay because they do not consider demand/supply differences in their models.
Relative Strength Index (RSI)
The RSI is a momentum-based technical analysis tool used to identify whether a security is undergoing market consolidation or if there has been a shift in market sentiment. It compares the size of recent gains and losses over a specified time to measure the speed and change of price movements within that security. The RSI oscillates between zero and 100, with high numbers indicating strong uptrends and low numbers indicating solid downtrends.
Bollinger Bands
Bollinger Bands are volatility bands based on the standard deviation of historical prices for a financial instrument plotted against Bollinger’s 20-day moving average. The upper band is produced by taking the security’s typical price multiplied by two standard deviations (which is represented by 20 days).
The lower band is produced by taking the security’s typical price multiplied by one standard deviation (which is represented by ten days). When these lines cross over each other, it means that the volatility of the asset has exceeded recent norms, which could be an early sign that an asset’s price will soon change direction.
Eliot Wave theory
Eliot Wave Theory is a technical analysis based on the idea that stock prices move in five waves. This theory assumes that sentiment moves in five waves, with the direction of movement determined by investors’ feelings about an asset’s market value. Waves are designated as “1” (distinct uptrends), “2” (weakening of the uptrend), “3” (are corrective waves within wave 2), “4” (distinct downtrends) and “5” (weakening of the downtrend).
In conclusion
You can use technical analysis tools to determine a stock’s worth and predict future prices. There are many tools available, so traders should familiarize themselves with as many as possible to gain an edge over other market participants.