Technical analysis is a method of predicting prices by considering charts of market movements for previous periods of time. Under the term “market movement”, analysts understand three main types of information: price, trading volume and open position.
For a more comprehensive analysis of price changes, along with fundamental analysis, technical analysis of the market, also calls internal analysis, can be usefull.
Unlike fundamental technical analysis, technical analysis studies the effect of supply and demand. That is, first of all, the price changes themselves, it is often called Chartism. Because it consists in the construction of various types of charts, graphs, in the study of the indicator of open positions and trading volumes, as well as other factors.
The main prerequisites of technical analysis are the following ideas:
- Fundamental factors affect quotes not directly, but indirectly. These factors are changing rapidly. Participants learn about important events at different times and interpret them differently. The market reaction embodies only a set of opinions and assessments.
- The mechanisms of the functioning of the market are objective and can be adequately described by reproducible regularities, manifested in the form of similarity and repeated repetition of certain characteristic features.
- The formation of a similar model in the market is a sign that a reproduction of a trend known from a number of numerous preliminary observations is emerging.
- The study of market reactions gives an idea not only of the main factors affecting supply and demand, but also of the psychology of participants, their attitude to these events.
This approach reflects the main position of the supporters of technical analysis, who believe that everything that happens in the market, from disasters to the psychology of traders, automatically leads to either an increase or a fall in price.
According to experts, graphic analysis can be useful for the following reasons:
- Price forecasting. Technical analysis specialists can predict price changes either taking into account fundamental analysis, or only on the basis of graphs and diagrams.
- Time determination. The analysis of charts is much better than fundamental analysis, suitable for accurately determining the time of opening and closing a position.
- The main indicator. If the actions of the market itself eliminate all the impact on it, then price movements can be considered as the main indicator of the market. This allows, firstly, to open and close positions without taking into account why prices move in one direction or in the other. Secondly, an unusual price movement can be perceived as a signal that some impact on the market has not been taken into account in the fundamental analysis and additional research is required.
Technical analysis is aimed at solving such problems as:
- Study of price dynamics in the past in order to build a certain model of its movement. This model is used to quantify the price level in the future, based on the study of the specific features and dynamics of price changes in the futures contract.
- Identification of the psychological mood of bidders, their willingness to buy or sell futures contracts.
The widespread use of technical analysis is also explained by the fact that a lot of small and medium-sized speculators do not have the opportunity to spend significant funds on modern methods of fundamental analysis. But at the same time they constantly receive exchange information. Which serves as the basis for making mechanical forecasts.
Technical analysis is based on three assumptions.
- Market movements take into account all factors, i.e. The chart of price changes shows the cumulative impact of all factors affecting the price (economic, political, psychological). For example, fundamental analysis states that if demand exceeds supply, the price of a commodity rises. The technical analyst concludes “vice versa”: if the price of a commodity rises, then demand exceeds supply.
- There are trends in the market, i.e. prolonged price movement in one direction. Therefore, the main task of technical analysis is precisely the definition of trends (their characteristics from the moment of occurrence to the very end) for use in trading. There are three types of trends:
- Bullish – upward price movement.
- Bearish – price movement down.
- Sideways (trading range) – The price practically does not move.
Although in its pure form there are no trends, nevertheless, you can always see which trend prevails in a certain period of time.
- Trends are repeated regardless of short-term random fluctuations that occur for one particular reason or another.
Recognizing a trend at its very beginning allows the trader to take the appropriate position. The method used to draw price movements and identify trends is a chart, or chart.
Methods of technical analysis are divided depending on the technology used into:
Graphic methods – methods in which visual images of market movements are used for forecasting. These methods were the first methods of technical analysis because of their ease of application.
Here are some examples of technical analysis methods:
- Moving averages
- Relative Strength Index (RSI)
- Fibonacci retracements
- Bollinger Bands
- MACD (Moving Average Convergence Divergence)
- Candlestick charts
- Stochastic oscillator
- Average Directional Index (ADX)
- Ichimoku Kinko Hyo (Ichimoku cloud)
- Volume analysis
Note that this is not an exhaustive list, but these are some commonly used technical analysis methods in the financial markets.
Two aspects
Strengths:
- Objective decision making. Technical analysis is based on analyzing charts and historical price data. This approach eliminates the emotional bias that can come with subjective analysis and allows for objective decision-making.
- Focused on price movements. Technical analysis is focused solely on price movements, which can be useful for short-term traders who are looking to profit from small price movements.
- Widely use. Technical analysis is a widely used approach, and many traders and investors rely on it to make their investment decisions.
Limitations:
- Limited information. Technical analysis only looks at historical price data and ignores other important information. Like company financials, news events, and market sentiment. This can result in missed opportunities or incorrect investment decisions.
- Subject to interpretation. Technical analysis requires interpretation of charts and indicators. Which can be subjective and open to different interpretations.
- Not always accurate. Technical analysis can provide false signals or be inaccurate in certain market conditions. Leading to losses for investors who rely solely on this approach.
Technical analysis is a popular and widely used approach to analyzing financial markets. While it has its strengths in identifying trends and patterns in price and volume data, it also has its limitations, including the subjective interpretation of chart patterns and the potential for false signals. Ultimately, technical analysis should be used in conjunction with other forms of analysis and should not be relied on as the sole method for making investment decisions.