Understanding technical analysis
Technical analysis is a trading discipline that involves studying and analyzing past market data with a view of predicting future price movements. It differs a great deal from the fundamental analysis that entails trying to evaluate the intrinsic value of a security.
Technical analysis as a methodology of trading focuses on price movements as well as trading signals, among other charting tools. The aim, in this case, is to try and evaluate the strength and weaknesses of a given asset while relying solely on past price movements and trading volume.
Over the years, it’s been proven that past trading activities, as well as price movements, have a significant impact on future price movements, regardless of the security under study. While some analysts rely on technical analysis independently, others combine it with fundamental analysis, among other concepts, to have a clear view of an asset’s actual value.
How technical analysis works
Technical analysts spend a good chunk of their time analysing price charts to try and identify key technical levels in the form of support and resistance levels. The in-depth analysis makes it possible to understand why price moved in a given direction and how it is likely to move in the future.
While analysing charts, technical analysts rely on various indicators to estimate price movement. Some of the commonly used indicators include moving average convergence divergence (MACD), trading volume history as well as RSI.
Intra-day technical analysts spend a good chunk of their time analysing five and fifteen minutes charts while long-term traders specialise in long time frame charts such as hourly and daily charts.
Technical analysis assumptions
Technical analysis is based on three main assumptions:
The market ignores fundamental factors
Most technical analysts ignore fundamental factors, such as financial reports, when it comes to predicting price movements. Instead, technical analysts maintain the notion that any emerging fundamental is already priced in an underlying security. By doing so, technical analysts avoid the temptation of factoring in emerging developments opting to focus solely on price movements.
Price Moves in trends
Analysts that specialize in technical analysis retain the notion that prices of securities move in short, medium, and long-term trends. Likewise, whenever a given trend is in play, then the price of the security will move in that direction until a new trend is established. It is, for this reason, there are short term, and long term trader’s that only rely on chart patterns to place trades.
History Repeats Itself
The notion that history repeats itself is one of the reasons why technical analysis pays close watch to past price movements. The repetitive nature of price movement is based on the fact market psychology tends to be very much predictable.
Bottom Line
Technical analysis makes it possible to identify the best entry and exit points by focusing on past price movements. However, it is important to note that there will always be an unpredictable market behaviour, given that, no form analysis would be able to provide accurate results. It’s therefore,important to consider other analysis methodologies such as fundamental analysis if you are to have a clear view of the market.