subject: Technical Analysis: Demystifying The Stock Market [print this page] Technical analysis is one of the primary means by which investors determine the stocks they will buy and sell. Looking at candlestick patterns from a stock's price chart can often enable a trader to make a better prediction and determine whether to get involved with the candidate.
When it comes to making stock trend forecasts, there are generally two schools of thoughts: fundamental analysis and technical analysis. Fundamental analysis delves into diverse areas such as the company's management and products, net income, debt and quarterly sales. Technical analysis utilizes statistics such as historical price and volume to focus on trends and interpret where the stock's price is likely to move next, which makes for more accurate predictions.
Stock market forecasts are easier to make after looking at the candlestick patterns on a price chart. The trends aren't as easy to spot when using a line chart or a bar chart, but the candlesticks provide signals that often seem to jump off the page. The candlestick patterns that form can send out clues as to the stock's inclination. They include:
1. Dojis: Although a doji is simply a sign of indecision among buyers, it grows in significance when it occurs at a support or resistance level.
2. Bullish engulfing candles: When a stock has a big up day it will often form a bullish engulfing candle, which consumes the candle formed by the previous session. When an engulfing candle is formed at a support or resistance level, it could indicate a change in momentum.
3. Hammer: When a stock moves lower at the open, but rallies to close well above the intraday high, it will form a hammer candlestick. It looks like a square lollipop with a long stick. This is often a bullish reversal candle.
4. Shooting star: This indicates the uptrend is about to end and may reverse or move sideways. The shooting star forms when the upper shadow is longer than the real body and lower shadow is small or non-existent.
5. Dark cloud cover: A bearish reversal pattern that continues the uptrend with a long white body. The next day opens at a new high, and then closes below the midpoint of the body of the first day candle, looking like a dark cloud covering it from above.
Many theories have been developed in the area of technical analysis. While many notions, such as the Random Walk Theory and Efficient Market Theory, have been discredited, some remain in favor, like the Dow Theory and the Elliot Wave.
The Dow Theory was developed by Charles H. Dow (of Dow Jones fame), who established six main tenets for his ideas. The Dow Theory said there were three main phases of a stock's movement: accumulation, trend following and distribution. Dow believed the trend was confirmed by volume and that the trend would last until definitive signals to confirm the end.
The Elliot Wave was developed by Ralph Nelson Elliott in the 1930s and stated that the market trends in a series of waves. The Elliott Wave is based on the Fibonacci proportions and a wave pattern and believed that smaller patterns morphed into a larger picture.
Recent contributions in the field of technical analysis continue today. Most recent additions to the body of knowledge have come from: George Lane, who developed Stochastics in the 1950s; Gerald Appel, who developed MACD in the 1960s; J. Welles Wilder, who developed RSI in 1978; and John Bollinger, who developed Bollinger Bands. Over the last 40 years more than 100 technical indicators have been created.
