Individuals who consider themselves to be technical analysts or chartists often hold the view that prices already reflect factors such as valuation and operational performance before investors have time to react to them.
They therefore spend their time studying price and performance charts, forming an investment view directly from this analysis rather than a detailed examination of an individual asset’s merits.
Many investors would probably be sceptical of adopting this discipline wholesale but there are some pointers you can take from basic charting techniques.
CHARTING THE RIGHT COURSE
Chartists believe they can forecast future price movements by interpreting past behaviour and recognising patterns and signals when they appear with the ultimate aim of identifying the trend.
It is an attempt to measure market psychology in a scientific way.
Chartists rightly see a market as a perpetual interaction between buyers and sellers. When there are more buyers than sellers, prices will rise and when sellers are stronger prices will fall.
These trends are prompted by the flow of information into the market and how it affects sentiment towards a stock.
Chartists believe markets have a herd mentality and movements can be predicted. So, it is not what you think about a stock that is important but what the market thinks.
Devotees of the charting technique aim to capture a trend by drawing lines that connect price points and examine them to see what they reveal.
Strong up-trends and down-trends are perhaps the simple areas to spot. These can be identified by the naked eye - in an up-trend share price peaks and troughs become gradually higher, while in a down-trend they become lower.
SPOTTING A SHIFT IN SENTIMENT
Chartists get most interested when sentiment is changing, and the trend looks like it is about to turn.
For example, large institutional investors may have decided to push the button on a programme of buying or selling, adjusting their positions over a period of time to avoid alerting the market.
Another basic approach is to look for support and resistance levels. If you look at the share price of a company over a 12-month period, there are likely to be several points when it has fallen or risen to a certain level before changing direction.
If a share price moves through the support or resistance it could be a signal that it is breaking out of its trading range.
