What Is Technical Analysis?

Posted by John Kelvin on Oct 14, 2019 2:26:09 PM

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The term “technical,” in its application to the market, has come to have a very special meaning, quite different from its ordinary dictionary definition. It refers to the study of the action of the market itself, as opposed to the study of the goods in which the market deals.

Technical Analysis is the science of recording, usually in graphic form, the actual history of trading (price changes, volume of transactions, etc.).

Prices rise if the investors think that the market is undervalued; when they buy. Prices fall if the investors think that the market is overvalued; when they sell. Because some part of the prices is based on the investor’s expectation or overreaction, the prices do not always properly reflect the intrinsic value.

People who are inside the business field usually know about their business better than people on the outside. The judgment of people inside must be quicker and more accurate than the outsider. And the investment activities of such people inside have been recorded as the movement of the prices and the trading volume. So, if you analyze details of such movement and volume, you might find the movements of the antecessors.

History repeats itself. Technical analysis focuses on the movement of the prices and the trading volume, and tries to forecast the future movement of the prices. Technical analysis concentrates on the change in prices, and therefore you would know the timing of buying and selling, but not the intrinsic value, so you may not know whether you are properly investing.

Fundamental analysis and technical analysis both have strong points and weak points, and therefore if we use the strong points of both types of analysis, we might be able to become better investors.

Technical Analysis Philosophy

There are three premises on which the technical approach is based:

1. The market discounts everything

All known information is reflected in the price. As soon as new information manifests, then it affects the price.

2. Prices move in trends

In technical analysis prices tend to move in observable trends with a slope to stay in the trend. The trend is considered to be flawless until the trend line is broken. 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.

3. History tends to repeat itself

Technical analysis is the study of what has happened to a currency in the past with the expectation that history is going to repeat itself. Many of the chart patterns in technical analysis use a long history of prices, and they are still believed to be relevant because they clarify patterns in price movements that often might repeat themselves.

Commonly used TA indicators

Typically, indicators and metrics have been the most important part of TA used by traders to determine what direction price is likely to move, based on the chart pattern and historical data presented in the past.

There are different indicators used by traders, but the most used technical analysis indicator is Relative Strength Index (RSI). RSI is a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. In the case of RSI, the range number runs from 0-100. This has its own traditional mathematical formula to determine the move. Assets are considered overbought when the indicator is above 70% and oversold when the indicator is below 30%, shown below.

RSI PIC

Other indicators are typically used, such as Bollinger Bands (BB), Simple Moving Average (SMA), Stochastic RSI and MACD.

The above mentioned indicators are important to most traders to know when to buy or sell, and can help indicate when the price is oversold/overbought.

In conclusion, technical analysis helps you trade ahead of what might happen, by using the historical price data as well as chart patterns, indicators and price theories.

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Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. Traders should always make sure they carry out their own research before buying any idea given. The views expressed in this article are the author’s and may not represent the views of EMX.

Topics: Education