What Is Technical Analysis?
Technical Analysis is a trading discipline employed to forecast the direction of prices through the study of past market data. Such as price and volume. Unlike fundamental analysis, which attempts to analyze the value of an asset on the basis of the business results, like sales and earnings. Technical Analysis focuses on price and volume.
Technical analysis is based on the belief that the past price changes and behaviours of an asset can be valuable indicators of an asset’s future price movements. It was first introduced by Charles Dow in his theory in the 1800s. Since then there have been many contributions to the dow theory by several remarkable researchers. Such as William P. Hamilton, Robert Rhea, Edson Gould, and John Magee.
Assumptions in Technical Analysis
In his editorials, Charles Dow repeatedly highlighted 2 basic assumptions that have continued to be the core sources behind the technical analysis framework. But over the years the field of technical analysis has built upon Dows theory. Today professional technical analysts generally follow these 3 assumptions.
- The market discounts everything: Technical analysts believe that every factor in the market, from a company’s fundamentals to market psychology is already priced into the stock. Therefore, nothing that is currently known, should affect the price of an asset.
2. Price moves in trends: Technical analysts believe that the price of an asset will exhibit trends. Regardless of the time frame which is being observed. In simple words, price is more likely to continue a past trend than move randomly.
3. History tends to repeat itself: Technical analysts believe that history tends to repeat itself. In simple words, Technical analysts believe that the price is of a repetitive nature. Trading psychology plays a key role in the movement of a price. The price tends to be repetitive because of the emotions like fear, and excitement. . Technical analysis uses chart patterns to analyze these emotions and resulting price movements to understand trends.
Technical Analysis vs. Fundamental Analysis
Technical analysis and fundamental analysis are the 2 main schools of thought when it comes to analyzing the financial markets. Both of these disciplines are used for researching and predicting future trends in stock, and commodity prices. And like any philosophy, Technique both have their fair share of advocates and adversaries.
Here are some of the key differences between the 2 approaches
Tools of the Trade
Technical analysis begins with analyzing the charts, Whereas fundamental analysis starts with a company’s financial statements. Fundamental analysts try to determine the intrinsic value of a stock by analyzing a company’s financial statements however Technical analysts believe a stock price is already discounted in relation to these factors. Instead, they put more emphasis on analyzing the stock chart.
Fundamental Analysis is a long-term approach. This “long term” can represent a timeframe as long as several years. In conclusion, Fundamental Analysts often wait a long time before a company’s intrinsic value is reflected in the market. Whereas Technical analysis is Short term approach.
Trading vs. Investing
One of the most distinct differences between technical analysis and fundamental analysis is that technical analysis and fundamental analysis have different goals in mind. Technical analysts often try to identify many short- to medium-term trades. Whereas fundamental analysts try to make long-term investments.
How to Use Technical Analysis?
Technical analysis attempts to forecast the price movement of an instrument. Instruments can be stocks, bonds, futures, currency etc. Technical analysts use hundreds of Technical chart patterns, technical indicators and tools in order to identify trading opportunities. Over the years technical Analysts have developed a number of trading systems that provide consistent profits.
Some of my favourite indicators are MACD, RSI and Moving Averagerages. And Some of my favourite Tools are Fibonacci retracement, Fibonacci Extension, and Trendlines.
The bottom line
Not everyone is a fan of the Technical analysis approach to analyzing the market. But over the years technical analysis has provided consistent results to many traders. however, It should not be the only tool in your pocket. It is best to have an understanding of different approaches to trading and investing while trading in the market. having a broader system helps minimize the flaws of different approaches and make a trustworthy and winning trading strategy. In the end, it all comes down to traders’ understanding of the market and its Market psychology.
Over the years many remarkable researchers provided material to help understand the science of technical analysis. In order to understand this complex approach one should look into the books that have been great sources of knowledge over the years. Here is an article with a list and general idea about these books on technical analysis –
Top 5 must-read books on technical analysis