Understanding Stock Technical Analysis


Understanding Stock Technical Analysis


What do the color of the year and stock technical analysis have in common? Trends and patterns! Let me explain and we’ll get into the technicals below.

Before a year begins, some people anticipate what the next color of the year will be. Superstitious people would want to wear something with a shade of that color when the clock strikes midnight on January 1st. Fashion labels would want to know what that color is as soon as possible so they can start producing apparel. In 2016, we were all surprised that the color of the year was actually two colors!

Now, who determines the color(s) of the year? It’s a color company called Pantone. Well, they’re not exactly a formal “authority” when it comes to dictating what the color of the year is but decades of experience have upped their credibility when it comes to all things color.

How does Pantone determine the color of the year, though? One word – trends! In an interview for a magazine, an Executive Director at Pantone shared that Pantone researchers travel around the globe to search for an emerging color by looking at what people wear or what color of make-up they have on. It’s not just in fashion. They also look at newly-released films to see what colors are consistently used. They also look at new technologies like cars and cell phones, and the techniques being used to create color. They also examine contemporary art and look at the trends and patterns in color.

Like the color of the year, the value of stocks can also be analyzed using the current trends and patterns in the market. This approach to analyzing stocks is called technical analysis.

What Is Stock Technical Analysis?

Stock technical analysis is the evaluation of investments based on the statistics obtained from market activity. People who use technical analysis evaluate their investment in stocks and other securities with charts and tools to determine patterns that may indicate future activity or the direction of the market. Pretty similar to what Pantone does, technical analysts rely on trends and patterns to determine their next move.

The objective of technical analysis is to determine the movements of the price of securities in the market and take advantage of these pricing trends. However, to be able to gather data, there should be existing data. Meaning, the data analyzed in technical analysis is something from the past or has already occurred. Technical analysts leverage past data and aim to induce future decisions.

Assumptions in Technical Analysis

One of your evil exes probably told you to stop jumping into assumptions at one point. However, if we’re doing technical analysis, then it is necessary to have some! This approach is quite subjective and often attempts to understand the emotions in the market. Having assumptions will, kind of, provide some logic and basis for those who employ this method. These assumptions are:

  • The market discounts everything.
  • Prices move in trends.
  • History tends to repeat itself (Oh, there we go!).

So, what do these three assumptions mean? The assumption that the market discounts everything basically believes that a company’s stock price already encompasses every factor that has or could impact the company. Meaning, all qualitative and quantitative factors are taken into account in the current stock price and there is no need to assess these factors separately. In fashion, for example, if you are willing to pay $100 for a dress shirt, that $100 already takes into account all of the things that can suggest the value of that dress shirt – the overall package. There is no need to analyze factors such as branding, artistry, uniqueness, and durability separately.

On the other hand, the assumption that price moves in trends believes that prices generally follow trends. Once that trend is established, future movement will likely follow the trend.

The assumption that history tends to repeat itself believes that price movements are repetitive, driven by the psychology of participants in the market. These participants or investors react the same way, regardless of the point in time, to the same type of situation or stimuli. For instance, in fashion, you have probably observed that trends just keep on repeating and repeating. The same thing can be said about stock price movements.