Technical analysis is the study of market data such as historical and current price data and volume in an effort to forecast future market activity. Historical price data is the most commonly used available data that is implemented into the analysis.
Historical market data is saved and forms charts over various periods of time. The technical trader can analyze varying periodical charts over a specific length of time for the basic purpose of picking the entry and exit levels of a trade. By studying the chart the chartist is able to get information at a glance that will hopefully represent the direction of the instrument in the future.
There is a never-ending argument between fundamentalists and technical analysts about which method of analysis will show the best results. Technical analysts will claim that all the fundamentals are already built into the price and so, apart from natural disasters and unexpected world events, the current price shows the market’s expected value taking all the known information into consideration. The chartists are in fact looking for patterns or repetitions in price movements to guess the likely outcome of future prices. In a word, they are looking for trends.
The field of technical analysis is based on three assumptions:
1. The Market Discounts Everything
A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, an instrument’s price reflects everything that has or could affect the instrument – including fundamental factors. Technical analysts believe that the instrument’s fundamentals, along with broader economic factors and market psychology, are all priced into the instrument , removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular instrument in the market.
2. Price Moves in Trends
In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.
3. History Tends To Repeat Itself
Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.
Technical analysis is a skill that improves with experience and study. The more you learn and practice the better you’ll be.