What is technical analysis?
|What is technical analysis?|
What is technical analysis?
What is technical analysis? Technical analysis is an analysis carried out on previous market data such as price and transaction volume. This analysis aims to use the prior market movements, market psychology and economical movements to predict the future movements of the market. Two comprehensive technical approaches are using price charts and technical indicators.
What does technical analysis tell us?
Technical analysis is a general strategy, which is used in different trading strategies. This strategy is mainly focused on price action method. Most technical analyses focus on specification of the future trend of the market, and predicting when this change occurs in the current trend.
Some technical analysts use trendlines, some use candlestick chart patterns and others prefer to use mathematical equations, known as technical indicators. Most technical analysts use a combination of existing tools to specify a suitable entry and exit point for each individual trade. For example, a chart pattern may highlight a suitable selling point, but the trader is looking to validate a breakdown via a moving average in another timeframe.
Technical analysis history
Technical analysis has been utilized in stocks for more than hundreds of years. In Europe, Joseph de la Vega used technical analysis techniques to predict the future market trends in Netherlands in 17th century. However, this method owes its current form to Dow Jones, Charles Dow, William P. Hamilton and many other analysts.
These people offered a new approach in the market which is the best way to measure fluctuations on the price chart. Later, a group of theories were issued by several primal analysts in 1984 in a book called “Technical Analysis of Stock Trends” authored by Robert Edwards and John Magee and caused them to be known globally.
The first uses of candlestick chart patterns goes back to Japanese merchants who were eager to specify trading patterns to optimize their rice harvest. Studying these patterns in the 90s decade in the United States got popular, when the internet was used regularly. Technical investors studied previous data in price charts and tried to generate new trading strategies based on their conclusions.
Being able to Identify candlestick chart patterns such as inverse patterns, doji, engulfing bullish and engulfing bearish patterns is very important to predict a new trend in the market.
How to utilize technical analysis
The essence of technical analysis is that the previous history of the market always reflects on the future and affects it in a certain way. Therefore, there is no need to check out the latest news and economical events.
Technical analysts usually believe that prices move in trends and when it comes to market psychology, the history is more likely to repeat itself. Two important parts of technical analysis include price charts and technical indicators.
When studying price charts, analysts try to identify supporting and resisting zones by looking at price chart patterns. These patterns are the foundation of psychological aspects, and are created to enable traders to identify breakouts and breakdowns.
For example, an ascending triangular pattern is a bullish pattern which shows key resistance zones. Exiting this resisting zone could lead into a major movement in the upward direction.
Technical indicators are a mathematical and statistical form of the data and apply several mathematical formulations on the price and trading volume to offer a final conclusion on this raw data. The most widely used technical indicators include moving averages which enable us to identify trends easier. There are other more complicated technical indicators such as moving average convergence divergence (MACD) which combines the effect of several moving averages together. A lot of trading systems are based on technical indicators, since they have the ability to measure several aspects of the market and report them in numbers. This makes it easier to compare different situations in financial markets.
Difference between technical and fundamental analysis
Technical and fundamental analysis are two widely used analysis strategies in financial markets. Technical analysts believe that the best approach is to follow the trend which has formed as a result of current actions and reactions in the market.
Fundamental analysts on the other hand, believe that market is always neglecting the true value. Fundamental analysts believe in trends that have formed as a result of fundamental factors such as balance sheets, economical events and other intrinsic features of the market. We can’t say which method is better, because there are both technical and fundamental traders in the market that are making profit.
However, in general, technical analysis allows for faster investment, while fundamental analysis needs more time to obtain a valid and accurate conclusion. Therefore, fundamental traders need to invest a little bit of their time in addition to their money, to succeed in financial markets.
Technical analysis limitations
Like any other trading strategies, technical analysis has its own downsides. Charts may be deceiving in some instances. The time periods you use for your moving averages may be too long or too short according to the kind of trade you intend to carry out.
Despite the downsides of technical analysis method, numerous traders are now using this strategy to make profit in financial markets. If you want to use this strategy effectively, you should create an account in an online forex broker. Aron Groups Broker allows its clients to take part in several financial markets such as forex, commodities, energy, stocks, indices, cryptocurrency and etc. and benefit from several technical analysis tools by offering them a comprehensive trading platform; MetaTrader 5. In MetaTrader 5, clients are able to trade in a wide range of markets and use advanced technical tools to analyze different financial markets.
Written by: Mohsen Mohseni (Aron Groups).