Technical analysis is the analysis of the financial markets to determine if the price will rise or fall in the future , its based on the principle that if a particular patter appeared in the past and made market to rise or fall the same pattern occuring now will have the same result on the market , so there are three basic assumptions that technical analysis is based on –
1. History always repeat itself – The first and the most basic assumption os that history will always repeat itself , if a chart patter occured few weeks ago and caused market to rise then in future if the same pattern occurs then we expect the market to rise again.
2. Market discounts everything- Another improtant assumption is that market discounts everything into the price , all the noise , all the rumours , all the news , that is the we don’t have to look for the events or the news happening we just have to trade the price assuming that market has already incorporated the news into the price.
3. Market moves in trends – Market always moves in three types of trends , uptrend , down trend and the side ways trend , at any time the market is in one of the trends mentioned , it may be rising, falling or doing nothing .When the market is in uptrend the market forms higher highs and higher lows each day on the charts , if its in downtrend it makes lower highs and lower lows , in sideways market the market moves pretty much between two points and remains in a range , hence called the range bound market.
The three market phases
As per dow theory at any time the market is one of the three phases – The accumulation phase , the participation phase and the distribution phase , let us learn more deeply what does each one means –
1. Accumulation Phase -Accumulation phase starts when the market has fallen much and now it has found its bottom and now it may again start to move upward and make higher highs and higher lows , here is the when most investors and smart traders enter the trade that is in the accumulation phase.
2. Participation Phase – Is when the other traders also see the stock rising and making higher highs and higher lows and they enter the trade after finding suitable entry level , participation phase is the level when retail traders generally find out the stock is in uptrend and they enter into trades , this is also the level when TV analysts start giving the buy calls to general public.
3. Distribution phase – This is the phase when traders and investors who entered in the accumulation phase come to the conslusion that the stock has risen to their targets and is over priced now so they start selling ( Dumping ) the stock thus trapping the innocent retail traders who were lured by TV analysts and social media chatrooms , such retail traders now start incurring losses so start dumping the stock thus further slinding the stock down , hence completing the whole cycle of accumulating , participation and distribution.