A Simplified Guide On Technical Analysis

What is technical analysis?

History repeats itself – the core notion followed by technical analysts. Technical analysts will focus on evaluating price fluctuations to predict future trading conditions. They believe that the price movements that occurred in the past will happen again in the future.

 Technical analysts follow three core assumptions:

1. Price changes in trends

2. History will likely repeat itself

3. The price of an asset already includes macroeconomic conditions.

Any financial instrument that has historical data can use technical analysis. In order to map out trends, analysts use charts. This allows them to visualize and understand data more clearly. It’s important to remember that just like any form of analysis, technical analysis is about probability and not so much about prediction.

In technical analysis, charting is an indispensable element. Technical analysts will use charts to map out trends, identify lucrative trading opportunities, and visualize historical data. Despite being a commonly used concept, technical analysis is subjective. It is not so much about prediction as it is about probability.

The history of technical analysis

Technical analysis dates back to the 17th century, where Japanese rice merchants used it. Homma Munehisa, a rice merchant from Japan, developed the candlestick technique. The concept was further expanded in the 19th Charles Dow, who created the ‘Dowe theory’ that became the basis for modern technical analysis techniques.

How is it conducted?

Technical analysts use technical indicators and charts to evaluate prices. Charting helps establish patterns that could be used as a base to enter and exit trades. So, while fundamental analysis seeks to establish a security’s fair value, technical analysis focuses exclusively on historical data, volume, and price to predict the price in the future.

Technical analysts have three fundamental goals:

• To know when to exit and enter the market.
• Not allow psychology to influence their trading.
• To profit from the market by observing price patterns.

Technical analysts use statistical tools called technical indicators. These are pattern-based signals produced by mathematical calculations based on price and volume factors. Traders use these widely customizable tools to interpret and understand data. Technical indicators are split into two categories: Leading and lagging indicators. Leading indicators attempt to forecast prices based on shorter time periods. Traders use while lagging indicators when a signal has already started determining a trend.

Some technical indicators include:

• Moving Averages and Moving Average Convergence (MACD)
• Parabolic SAR
• Relative Strength Index (RSI)
• Bollinger bands
• Chaikin Oscillator

Limitations of Technical Analysis

Some analysts believe that relying solely on historical data is dangerous. As markets evolve and global conditions change, it is challenging to depend exclusively on past price patterns. But with the same reasoning, fundamentals may not be the best technique to follow as they tend to narrow down objective thinking. In other words, depending too much on either technique is not ideal in any scenario.