All smart investors do some form of due diligence before making any investment or trade. There are two basic forms of investment analysis; fundamental and technical. Fundamental analysis involves evaluating an investment on the merits of its balance sheet, products, supply and demand, and the economic climate. Technical analysis assumes that the market has discounted the fundamental information (the market knows the information before it becomes public) and seeks to interpret the market reaction to this information by analyzing price movements for a given investment.
The charts do not cause the market to go up or down. They simply reflect the market's perception of the fundamentals. In essence, it is a matter of cause and effect. Fundamental analysis seeks to interpret cause, while technical analysis interprets effect. The fact that XYZ's earnings continue to grow is the fundamental cause for higher stock prices while the actual price range in which XYZ finds support and resistance is the effect.
Support and resistance? Prices move in trends, and these trends tend to continue in the same direction for extended periods of time. The technician, through the use of charts and other indicators, attempts to identify these trends. Every investor has a price at which he becomes concerned about continued ownership of his stock and decides to sell. When enough investors have a similar price in mind, there are more sellers than buyers in the market and the price of the stock will fall. This price is referred to as resistance. Similarly, at some price, investors will view a stock as being undervalued and decide to buy. The price at which more investors want to buy than sell is considered support. As investor psychology changes over time, so do the areas of support and resistance. The key to market timing is identifying support and resistance areas. Once identified, we attempt to buy at support and sell at resistance. This is the heart and soul of technical analysis.
Charts are the basis for technical analysis. They offer a visual aid to interpreting trend and market action. The old axiom "a picture is worth a thousand words" was never more appropriate. Even the novice can do basic chart interpretation. We can all look at a chart and say "I wish I had bought this stock then" or "Wouldn't it have been great to take profits then." Hindsight is easy and you can't always be right, but with the right tools and a little work, you can decrease your risk and increase your profits.
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