What is technical analysis

 

Some claim that descriptions of the Dutch financial markets written in the 1700s by Amsterdam-based merchant Joseph de la Vega are the first sources of certain elements of technical analysis. Richard W. Schabacker wrote multiple books on technical analysis between 1920 and 1930.

Charles Dow, the editor and co-founder of Dow Jones, is the source of Dow hypothesis. At the close of the 20th century, he is credited with inspiring the use and advancement of contemporary technical analysis. Dow is a well-known theorist worldwide.

Introduction

Technical analysis uses past price charts and market data to analyze and forecast changes in the value of securities in the financial markets. It is predicated on the notion that a trader may forecast future price trajectories with some degree of accuracy provided they can recognize past market patterns.

Along with fundamental analysis, it is one of the two main schools of market analysis. Technical analysis is only based on an asset’s price charts, but fundamental analysis is concerned with an asset’s “true value,” taking into account both intrinsic value and the significance of outside forces. The only method for predicting future moves on a chart is to find patterns.

What is Technical Analysis?

Technical analysis is a tool, or approach, that uses market data to forecast the likely future price movement of a security, like a stock or currency pair.

The idea that all market participants’ buying and selling collectively accurately reflects all pertinent information about a traded security and, as a result, consistently assigns a fair market value to the security is the theory supporting the validity of technical analysis.

Technical traders think that the best predictor of future price action is the market’s previous or present price action.

For generations, traders, analysts, and investors have employed technical analysis, which has gained widespread recognition from both the academic and regulatory communities. This is especially true when it comes to the behavioral finance components of technical analysis.

What are the assumptions  that underpin technical analysis?

1. Everything is discounted in the market.

The price of a securities already accounts for all pertinent information, including that obtained through fundamental research. This implies that all that is needed to predict future movements is to examine price action.

2. Trends drive price movements

The idea that price movements follow recognizable patterns and trends that recur over time is the basis for technical analysis. Trends that are choppy, horizontal, upward, and downward are common.

3. The past frequently repeats itself

Market psychology explains why price changes are recurrent. Over time, similar market triggers tend to elicit similar responses from traders and investors. Chart patterns and price behavior that are predictable are examples of this.

Why Is Technical Analysis Important?

Because it offers a disciplined, unbiased framework for identifying high-probability trading and investing opportunities, technical analysis is a crucial skill for traders and investors. Technical analysis is important for the following reasons, in particular:

Reasons why possessing technical analysis skills is crucial for traders:

• Determines support and resistance levels that are helpful for putting stop losses and taking gains; helps schedule market entrances to maximize the likelihood of trading in the trend’s direction.
• Allows for the discovery of trading opportunities in markets that are range-bound or sideways.
• Delivers trading signals ahead of time compared to basic data releases.
• Eliminates emotion from trading by paying attention to the signals and data
• Able to use volume data to determine changes in supply and demand
• Beneficial across all markets, including equities, currency, commodities, and cryptocurrencies

What are the downsides of Technical Analysis? 

Subjectiveness is possible

Because various traders may interpret the same chart in different ways, technical analysis can be subjective. This may cause traders to receive contradictory signals and become confused.

Does not take into consideration basic factors

Technical analysis ignores essential elements like economic statistics or corporate news and is only dependent on price and volume data. In some market situations, this may reduce the technical analysis’s accuracy.

Not suitable for any market situation.

Technical analysis might not be effective in every market scenario. For instance, technical indicators may give erroneous signals or be unable to correctly forecast price moves in extremely turbulent markets.

Needs expertise and experience

To be effective, technical analysis needs a certain amount of training and expertise. Accurate chart and indication interpretation may be challenging for novice traders.

Minimal attention to fundamental analysis

The underlying fundamentals that drive the market are ignored in favor of price and volume data in technical analysis. Prices can occasionally move irrationally and independently of fundamentals. Thus, trading without taking fundamentals into account carries a risk.

Technically speaking, a stock may be oversold, but if the company’s fundamentals are weakening, the downtrend may persist rather than stop. In order to comprehend the sustainability of trends suggested by technical analysis, fundamentals provide context.

Conclusion

In conclusion, technical analysis is a widely used approach in modern trading with several strengths and weaknesses. Its simplicity, objectivity, and focus on timing make it accessible and valuable for many traders, especially in trending markets. However, its limitations, such as the lack of fundamental analysis, subjectivity, and susceptibility to false signals, mean that it may not be suitable for all trading situations. Traders often find success by combining technical analysis with other forms of analysis and risk management techniques to create a well-rounded trading strategy. Ultimately, the effectiveness of technical analysis depends on the trader’s skill, discipline, and the specific market conditions in which it is applied.