What are Foundation principles?
Technical Analysis is branch of Stock research which deals with prediction of movement of Stock and Index prices based on graphical and computational tools.
All of the tools we will discuss or exists in market is based on only two entities Price and Volume. It is different mathematical computation performed on these two entities to arrive at a conclusion.
But before diving into these indicators and tools it is better to understand the concept which gave rise to Technical Analysis field of Stock market research. You may have seen Technical analysts in business news channel.
So lets understand the theme concepts of it before diving into more details in subsequent chapters. Understanding these terms is important for clear vision while discussing advanced topics.
3 Foundation Principles
There are three foundation principles on which whole concept of technical analysis depends on. These concepts were then expanded into many theories and tools for predicting price movement.
As of this writing many more tools and sophisticated algorithms are used to predict the behavior and make judgement based on that.
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1. Price moves in trend
This is very important concept. You may have heard analysts saying follow the trend trade in direction of the trend. The reason is simple. Stock Prices or Index prices moves in direction.
Stock market is nothing but representation of what majority thinks about direction prices should go. The mindset of people is created based on the perception about economical and political conditions. They hope in future things will improve more resulting increase of price.
This perception continues until and unless there is some event which changes that perception like Election and any other Geo political issues. Market changes direction after these obstacles.
This postulate is base of many tools which help you analyze and understand the trend of market. They also help you predict any trend reversal as well. We will see these later in the chapters.
2. History repeats itself
History we have learned as subject in schools. People always quote you should learn from history. Those who do not learn from history perish. This lesson holds good for Stock markets as well.
How often you see articles about performance of Indexes on a particular month or day? You may have heard Support or Resistance (we will cover these in details later). These concepts are based on History repeats itself.
For example if price of a stock reaches a point from where it fell last time then many people become skeptical. They think prices may again fall from that point. If prices overcome the point they become fearless and start buying more aggressively.
If you read the Dow Theory chapter then you can easily relate History repeats itself with Major, Secondary and Minor trend concepts explained in that chapter.
3. Prices are ultimate indicator
How you make money in Stock Market? The answer is simple if the prices are more than what you payed. So if you are seeing price performance of a company for long period of time say 10 years or so then prices should be increasing.
If prices are increasing then you have made money if not then you have lost money. Whether a company is doing great or not can be simply denoted by price movement of stock.
Any company however great it claims to be if does not give positive return to your capital is useless. This concept I have used in Fundamental Analysis of Companies.
At any given point every geo political and economic situation is reflected in stock prices.So price is the ultimate king.
Conclusion
These principles look simple and easy to understand. But they are difficult to assimilate and apply in real market. People tend to forget these simple rules and rely more on heavy lifting tools.
You should always keep in mind these rules and keep the tools handy to help you understand and interpret these rules. It is secret sauce to understand the market better.