Key Principles Of Technical Analysis
While some evidence suggests traces of science date back to the 17th and 18th centuries, technical analysis was used in traditional trading from the 1920s to the 1930s, when Charles Dow and William Hamilton formalized the concepts of price trends to understand the movement of markets.
The area of technical analysis is based on three assumptions:
- Price moves along the trend,
- The market drops everything, and
- History tends to repeat itself.
Unlike fundamental analysis, which assumes that economic and financial factors are the best indicators of supply and demand for assets, technical analysis is based on the idea that future market trends can be predicted by interpreting past and present results.
Technical analysts widely use various market indicators, some of which are mathematical price conversions, which usually include volume changes, up/down data, and other inputs.
The market's psychology explains the repetitive nature of price movements. Technical analysis is based on plotted trends, the general direction of the market as a whole, or the price of an asset.
Price moves along the trend
To successfully invest or trade stocks, options, foreign exchange and even mutual funds, you need to understand market trends, which can only be learned from technical analysis. The whole purpose of tracking market price changes is to identify trends in the early stages of its development so that trades can be carried out in the direction of these trends.
Technical analysis uses chart models to analyze general market trends and price history. Using charts, technical analysts try to identify price patterns and market trends in financial markets and try to use these patterns.
Price discounts everything
The idea is that all the relevant market information is already reflected in the price. Technical analysts believe that anything that can affect a market - fundamentally, politically, psychologically or otherwise, affects the price of that market.
All that remains is the analysis of price movements, which technical theory regards as a product of supply and demand for certain stocks on the market. It remains only to analyze the price movement, which technical analysts regard as a result of supply and demand for a particular trading instrument in the market.
History repeats itself
Another important factor in technical analysis is that history often repeats itself, especially in terms of the entire market and the price changes of an individual instrument. Market psychology makes price changes repeat themselves, driven by emotions such as fear or anxiety. Even if it is the oldest technical analysis tool used for more than 100 years, it is still relevant. Charts often form historical patterns, and analysis of past patterns helps technical analysts predict likely future market trends.
This principle is based on the belief of technical analysts that trading is closely related to probability, and the analysis of historical patterns gives the analyst an advantage over opening a trade.
This is often done by plotting the appropriate data to generate short-term trading signals. Viewing prices through illustrated area charts and patterns can speed up trading as timing requires faster decision-making.
Technical analysis versus fundamental analysis
Unlike fundamental analysis based on observing macroeconomic data and analyzing economic relations, foreign exchange technical analysis is based on the simple idea that currency prices include all relevant information that affects the foreign exchange market. Of course, unforeseen events—such as natural disasters or geopolitical tensions—may affect specific markets.
Still, technical analysts are not interested in the reasons. However, technical analysts believe that at any given time, the stock price reflects all factors that have or may affect the company, including fundamental aspects. Technical analysts believe that the company's fundamentals, broader economic factors and market psychology, are valued based on stocks. There is no need to look at these factors separately.
Technical analysis and human psychology
Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing the basic characteristics of stocks. Although the subject is applicable to all stocks with historical trading data, technical analysis is usually very popular in the foreign exchange market because traders tend to focus on short-term price changes.
Technical analysis is usually used to generate short-term trading signals from various charting tools. Still, it also helps to improve estimates of the strength of stocks in the broader market or one of the industries. Technical analysts do not try to measure the intrinsic value of a stock but use stock charts to identify patterns and trends that suggest the stock's future. Retail traders can make decisions based solely on stock price charts and similar statistics.