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Trading

What’s technical analysis?

Technical analysis (TA) is also known as charting. It’s a type analysis that uses historical volume and price data to predict market behavior in the future. This approach can be used to analyze stocks and other assets in traditional financial markets. However, it is also used in digital currency trading in cryptocurrency markets.

Fundamental analysis (FA) looks at many factors that affect the price of an asset. TA, however, is focused only on historical price behavior. It is used to analyze asset price fluctuations and volume data. Many traders also use it to try to identify trends or trading opportunities.

Although technical analysis was first developed in Amsterdam (17th century) and Japan (18th century), modern TA is often credited to Charles Dow. Dow, a financial journalist and founder The Wall Street Journal was the first to recognize that markets and individual assets often move in accordance with trends that can be segmented or explored. His work led to Dow Theory, which stimulated further technical analysis.

In its early stages, technical analysis was based only on manual tables and calculations. However, TA became more widespread and is an important tool for traders and investors.

What is technical analysis?

TA, as mentioned above, is basically the study and comparison of asset prices in the past and present. Technical analysis assumes that fluctuations in asset prices are not random but can often be identified trends over time.

TA, at its core is an analysis of the market forces of supply or demand which reflect market sentiment. The price of an asset is simply a reflection on the forces of buying or selling. These forces are closely tied to investors’ emotions (essentially fear and greed).

Notably, TA is more reliable and efficient when markets operate under normal conditions with greater liquidity and volume. Large volumes make markets less vulnerable to price manipulation or other external influences that could cause false signals, rendering TA useless.

Traders use various charting tools called indicators to study the prices and identify potential opportunities. Technical analysis indicators are useful for traders to identify trends and provide information about future trends. Traders may use multiple indicators to reduce the risk of errors in TA indicators.

Common TA Indicators

Traders using TA typically use many indicators and indicators to identify market trends based upon charts and historical price movements. Simple Moving averages (SMAs), one of the most popular and well-known indicators of technical analysis, are among the many. The SMA, as the name implies, is calculated using the closing prices for an asset over a specified period. Exponential Moving Average (EMA), a modified version, is a modified SMA. It weighs newer closing prices more than older ones.

The Relative Strength Index, (RSI) is another popular indicator. It is part of a group of indicators called oscillators. Oscillators are not like simple moving averages which track price movements over time. Instead, they apply mathematical formulas and produce readings that fall within certain ranges. This range for RSI is 0 to 100.

Another type of oscillator is the Bollinger Bands (BB), which is very popular with traders. The BB indicator consists two sides bands that wrap around a moving average line. It’s used to detect overbought or oversold market conditions and to measure market volatility.

Some indicators, other than the simple and more straightforward TA tools can rely on additional indicators to generate data. Stochastic RSI can be calculated by using a mathematical formula to a regular RSI. The Moving Average Convergence Divergence Indicator is another popular example. To create a MACD, subtract two EMAs in order to generate a main line (MACD). A second line, also known as a signal or second line, is generated by subtracting two EMAs. A MACD histogram is also calculated using the difference between these lines.

Trade Signals

Indicators are useful in identifying trends but they can also be used for information about entry and exit points (buy/sell signals). These signals are generated by certain events on an indicator chart. If the RSI is greater than 70, it could indicate that the market has overbought. This logic is also applied when the RSI falls below 30. This signal can be interpreted as a sign of an oversold market.

Technical analysis signals are not always reliable and TA indicators can generate a lot of noise (false signal). This is particularly true for cryptocurrency markets which are smaller than traditional ones, and therefore more volatile.

Criticism

Although TA is used widely in many markets, experts find it to be unreliable and controversial. It is also often called a selffulfilling prophecy. This term refers to events that happen because many people believed they would.

Critics claim that in financial markets, if investors and traders rely on the same type of indicators such as support and resistance lines, then the likelihood of these indicators working increases.

Many TA supporters argue that each charter is unique in its way of analyzing charts, and can use the various indicators. It would be almost impossible for many traders to use the exact same strategy.

Fundamental Analysis vs. Technical Analysis

Technical analysis assumes that market prices reflect all fundamental factors associated to a particular asset. Fundamental Analysis (FA), however, is broader than the TA approach which focuses mainly on historical volume and price data (market charts), but it focuses more on qualitative variables.

Fundamental analysis assumes that future returns to assets are not dependent on historical data. FA, which is basically a method to calculate the intrinsic value of a business, company or asset, relies on a variety of micro-economic conditions such as market competition, company governance, growth rates and the state and industry.

We can therefore see that FA, unlike TA which is primarily used to predict price action and market behaviour, is a method for determining whether an asset is overvalued based on its potential and context. Fund managers and long-term investors prefer fundamental analysis to technical analysis, which is mainly used by traders in short-terms.

Technical analysis relies on quantitative data, which is one of its greatest strengths. This allows for an objective analysis of price history and eliminates some of the guesswork associated with fundamental analysis.

Despite working with empirical data, TA can still be influenced by subjective biases and personal biases. A trader who is predisposed to a particular conclusion about an asset will likely be able manipulate their TA tools to keep their biases and reflect their preconceived notions. This is often done without their knowledge. Technical analysis can also fail when there is no clear trend or pattern in the markets.

Last Thoughts

Many people consider the combination of TA/FA an easier and more rational option, despite long-standing disagreements and criticisms. Although FA is generally used to describe long-term investment strategies (such as when trying identify favorable entry or exit points), TA can provide valuable information about the market conditions in the short-term that traders and investors can use.

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