Technical Analysis is a market analysis doctrine which aims to evaluate assets and securities in order to find the right opportunities to trade. It focuses on trading activity, which is represented by the movements of price graphs and the volume of trading. Technical analysts use indicators and instruments in order to decide where the right opportunities lie. Fundamental analysis on the other hand tries to evaluate the underline value of the asset.
A Short History
Though aspects of technical analysis have been developed as far back as the 17th century in Holland and in the 18th century in Japan, most people trace the history of technical analysis back to the early days of the 20th century and the work of Charles Dow (what is know as Dow Theory) who, along with his partners, founded the Wall Street Journal and the Dow Jones Industrial Moving average. Charles Dow, and writing partner William Peter Hamilton, published the books Stock Market Theory and Technical Market Analysis, and were later expanded upon by others who took Technical Analysis into the future. Today Technical Analysis has moved from books and papers into the digital world with advanced high-tech software replacing the pencil and pen.
The Logic Behind Technical Analysis
Technical Analysis, unlike fundamental analysis, assumes that all the information available is reflected within the price graph of the asset. Price fluctuations from this perspective are never random and, therefore, clear trends can be identified and followed. History, as reflected in the price graph, repeats itself, and the trader can identify patterns in the graph that can be used to identify trend reversals or corrections.
HOW TECHNICAL ANALYSIS IS IMPLEMENTED?
Using Technical Analysis one can forecast the price fluctuation of virtually any asset, be it stock, bond, commodity, index or derivative based on supply an demand. Price movements reflect changes in the supply and demand of a certain asset, but they are not the only instrument at hand for the analyst. Apart from graphs, it is common for the technical analyst to use volume and other indicators which can give one clues to the current trend and its strength.
Since the birth of Technical Analysis, many indicators have been added to the toolkit of the trader, attempting to accurately forecast the future development of prices. Some indicators may focus on trend identification while others try to evaluate its strength and durability. Some of those are RSI (Relative Strength Index), Moving Averages, Momentum, etc.
Indicators are usually applied to charts at different time frames. Day traders may use charts ranging from one-minute to hourly, whereas traditional traders may look to weekly and monthly charts for clues.
Apart from indicators, technical analysts may also turn to pattern recognition. A trader may look at the past movements of the graph to try and find movements which will repeat themselves in the future. For example, some assets will throw a ‘kangaroo tail’ when testing a new price before the market rejects it and cause a reversal of the trend. Pattern recognition relies on the idea that history repeats itself, and that traders behave in predictable ways.