Graphical and technical analysis: how to use it in the stock market?

There is more than one method to invest in the stock market. The investor Warren Buffett considers that technical analysis and graphical analysis have no value, if not mystical. With their esoteric figures and indicators, it is true that it sometimes looks more like astrology than analysis.


But chartists counter that in a volatile market, it is better to decipher investors' intentions than to dissect balance sheets. Many respected investors use technical and chart analysis to make their decisions.


In practice, it may be worthwhile to use fundamental analysis to do your stock-picking and to use technical and chart analysis to know when to buy those stocks. But how do you go about it? Discover in this article and in the infographic how to use the principles of technical and graphical analysis to invest in the stock market.


You will also find in this article the main characteristics of chartist analysis and what differentiates it from fundamental analysis, which graphical and mathematical indicators allow you to anticipate the evolution of prices, what is the interest of this method for the investor, and in which situation to use it.


Chartist analysis: what are chart analysis and technical analysis?

Investing in the stock market is not innate and in order to invest successfully in the financial markets, the selection of securities must be based on an analysis of the stock, whether it is a graphical and technical analysis or a fundamental analysis, or a combination of both.


Fundamental analysis focuses on the company's economic and financial data (microeconomics) as well as elements related to the economic system in general, geopolitics and politics, the regulatory framework, societal trends, etc. (macroeconomics). 


Chartist analysis, consisting of chart analysis (figures representing market prices over a given period of time) and technical analysis (method of mathematical calculations), is based on the study of movements and trends in market prices.


Chartist analysis is therefore based on the study of charts representing the prices of the securities studied to determine the future direction (short or medium term) of the prices. To do this, the practitioners of this technique use a battery of graphical and technical (or mathematical) indicators based on the study of past prices, i.e. the observation of the evolution of the percentage fee and buying and selling volumes.



The basis of graphic analysis: price curves

A fee curve is a series of expenses over a given time. One type of curve that is very popular with investors is the one constructed with Japanese candlesticks. They gather the essential information of a session, namely: the opening, the high, the low, and the closing. Indeed, a candle consists of a frame and wicks or flames represented through the ends. If the final fee is better than the whole fee, the candle is green. If the final fee is decreased than the whole fee, the candle is red. The length of the body expresses the strength of the bullish or bearish movement: the longer it is, the bigger the gap between the opening and closing price.


Chart indicators that allow the investor to analyze prices

The investor wishing to choose the best moment to take a position on an asset will be particularly vigilant to the zones of resistance and support, these psychological prices which one can identify via a careful study of the prices and the location of the zones of resistance and support. They correspond to thresholds that the stock has failed to exceed (upwards or downwards) on several occasions over a given period.


In the event of a bullish rally in the stock, you should pay particular attention to the threshold at which sellers usually overtake buyers (resistance), which can lead to a price decline. At this level, expenses fail to rise. On the other hand, if this resistance is breached, it is a very strong positive signal that prices will rise again until the next resistance.

If a stock falls, this time you should pay particular attention to the threshold at which buyers usually overtake sellers (support), which can lead to a price rise. At this level, the fall is cushioned and the price goes back the other way. On the other hand, if this support is breached, it is a very strong negative sign that the price will fall again until the next support.

These supports and resistances mark the psychological prices which will influence the evolution of the share price. Resistances will become supports if they have been crossed upwards and supports can become resistances if they are crossed downwards.

A well-informed investor knows that it is advisable to buy a stock when it breaks through an upward resistance and sell it when it reaches the next resistance.

The more difficult it is for a stock to break through a resistance, the more important that resistance is. The same is true for supports: the more a stock fails to break below support, the more important it is.
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Technical and mathematical indicators to analyze prices
In addition to analyzing historical price levels, we also study various mathematical indicators developed to observe trends, volatility, and the buying or selling psychology of a market. These range from stochastic to Bollinger and MACD. Through these indicators, statisticians try to model the evolution of prices. Indeed, they are convinced that the past can shed light on the future and that past prices can therefore be projected to predict future prices: history repeats itself. They assume that all the information available on financial security is already faithfully integrated into its price. From this perspective, there is no reason to try to identify stocks with undervalued fundamentals and it is better to work on detecting trends early on to buy or sell them before anyone else.

Graphical and technical analysis: detecting trends in stock prices thanks to moving averages

At the heart of the chart, analysis is the observation that prices move in three ways. They go up, down, or stagnate. The key to success is to spot one of these three trends and stick with it until you spot another signal that the situation has changed. One way to do this is with moving averages.

One of the most commonly used is based on closing prices. To calculate the 5-day moving average (MA) (MM5), simply add the last 5 closing prices and divide by 5.

Example:
  • Day 1 Price: 10
  • Day 2 Price: 12
  • Price for day 3: 10
  • Price day 4: 13
  • Course day 5: 15

MM5 = "(10+12+10+13+157/5 = 60/5 = 12."

If the following day the last charge is once more 15, we get MM5 = 65/5 = 13, and so on.

An increasing MM can indicate an uptrend, just as a decreasing MM can indicate a downtrend.
You can also gauge the trend by looking at whether the last price is above or below the moving average.

If a moving average of 13 over a short period of time exceeds a moving average taken over a longer period of time, you have a buy signal. Likewise, if it crosses it "from above", you have a sell signal.

Moving averages are very reliable, especially when they are supported by rising trading volumes, which can indicate that institutional investors (the so-called "zinzins") are reinforcing the trend.

But trends never last as they come and go.  It is consequently in particular vital to pick out the sign that suggests a extrude in trend.

Buying stocks at the bottom of price curves

Stock prices don't usually move in a straight line. You'd think! Instead, they have peaks and valleys on either side of the trend line.


During an uptrend, a short-term trader will therefore try to maximize his or her gains by buying stocks at the many lows that mark the path of the general uptrend.

How often the trader does this depends on his interest in trading and his trading costs, but a good rule of thumb is to use long-term charts to spot trends, and shorter-term charts to identify buying and selling opportunities.

Resistance points form at the top of every extended uptrend as traders take profits, and at the bottom of every extended downtrend as stock-pickers buy back stocks at good prices.

By keeping an eye on a price's previous resistances, the chartist extends the horizontal line into the future, hoping that this will allow him or her to identify the next resistances and, as the case may be, buy or sell.

Graphical and technical analysis for investing in the stock market: an investment strategy

Graphical analysis can, in the same way as fundamental analysis, provide good tools for investing in the stock market. But like any tool, it is never as good as the person who uses it.

A "bullish" or "bearish" chartist will often try to find a line to justify his point of view. A bullish trend is of little use when a company issues a profit warning. But let's not throw the baby out with the bathwater: technical and chart analysis is very useful, but it is only one factor among others in the success of an investment strategy.

It should also be noted that technical analysis is a very good complement to fundamental analysis. Indeed, fundamental analysis is a precious help when it comes to selecting stocks with potential, while technical analysis can help you define the best time to buy these stocks.

And you, dear reader? Are you a chartist or a fundamentalist? Or both?

All our information is, by nature, generic. It does not take into account your personal situation and does not constitute in any way personalized recommendations for the realization of transactions and cannot be assimilated to a financial investment advice service, nor to any incitement to buy or sell financial instruments. The reader is solely responsible for the use of the information provided, without any recourse against the publishing company of Cafedelabourse.com being possible. The publishing company of Cafedelabourse.com cannot be held responsible for any error, omission, or inappropriate investment.

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