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The Basics of Technical Analysis

The Basics of Technical Analysis

The means of analyzing securities and make investment decisions can be broadly divided into two categories: technical and fundamental analysis. While fundamental analysis involves analyzing the features of a company or asset in order to estimate its value, Technical analysis employs an entirely different approach; it doesn’t consider the value of a commodity or currency, it focuses solely on the price movements in the market.  

Despite all the exotic and fancy tools it utilizes, technical analysis really just studies demand and supply in the market in an attempt to predict the direction, or trend of a particular asset. In order words, technical analysis tries to understand the emotions in the forex market by studying the market itself, as opposed to its component. If you understand the limitation and benefits of technical analysis, it can offer you a new set of skills and tools that will enable you to be a better investor or trader.

This article will try to explain in a broader term the subject of technical analysis. We will try to shine the light on the basics, providing you with the solid foundation needed for more advanced concept along the line.

 What is Technical Analysis?

Technical analysis is a means of evaluating assets by analyzing the data generated by the market activity, such as the volume and past prices. Typically, technical analysis does not attempt to measure an asset's intrinsic value but instead use charts and other valuable tools to pinpoint patterns that suggest future activity.

Just as there are lots of investment styles on the fundamental side, there are also many different forms of technical investors. Some rely on the use of technical indicators and oscillators, other use chart patterns, and most utilize a combination of the two methods. In any case, technical analysts exclusive utilization of historical price and volume statistics is what separate them from their fundamental counterpart.  Unlike fundament analysts, technical traders don’t care whether an asset is undervalued- the only thing that is important to them is an asset past trading statistics and what information this data can provide regarding the direction of the asset in the future.

The field of technical analysis is based on three assumptions:

1.    Price move in trends

2.    History tends to repeat itself

3.    The Market discounts everything

Price Moves in Trends

Price movements are believed to follow trends in technical analysis.  This means that as soon as a trend is established, the future price movement is likely to follow the same direction as the trend than against the trend. A majority of all technical trading strategies are based on this assumption.

History Tends to be Repeated

Another important tenant of technical analyses is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movement is usually attributed to market psychology. That is to say, market participant tends to provide a consistent reaction to similar market stimuli over a long period of time. Technical analyses employ chart patterns to analyze market movement and understand future trends. Though many of these charts have been in existence for more than 100 years, they are still believed to be very relevant because they typically illustrate patterns in price movements that often repeat themselves.

The Market Discount Everything

One main criticism of technical analysis is the fact that it only considers price movement, without paying attention to the fundamental factors of the asset. However, technical analysis generally assumes that, at any given time, an asset’s price reflects virtually everything that has or could affect the asset- including all the fundamental factors. Technical analysts generally believe that the asset’s fundamentals along with broader economic indicators and market psychology are all priced into the asset or stock, eradicating the need to consider these factors separately. This leaves only the price movement analysis, which technical theory views as a product of demand and supply for a particular asset or stock.

Multiple Purpose

Unlike most other tools, technical analysis can be used on any security with historical trading statistics. This includes futures, commodities, stocks, forex and fixed-income securities.  The concept of technical analysis can be applied to almost any type of securities. Though, technical analysis is more frequently associated with forex and commodities, where the investors are predominantly traders.

 

 

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