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Technical Analysis

Introduction to Technical Analysis

Let’s begin by trying to define what technical analysis is. Technical Analysis can be said to be - 

  • study of market action – price, volumes and open interest
  • goal is to forecast future price trends

The Three Premises of Technical Analysis are - 

  1. Prices discount everything – all known information – political, economic, psychological is reflected in prices. Therefore we only need to study price action.
  2. Prices move in trends – as opposed to the random walk theory which claims prices are serially independent such as a Brownian motion simulation. Now when we understand more on the market landscape and see how prices are formed we will see that there is some market psychology behind the prices as these prices are constantly affected by market maker psychology. We will understand the psychology behind the formation of supports, resistances, trends etc.
  3. History repeats itself – this is an important premise since we use patterns, formations, indicators to determine future trends. Since these tools have successfully worked in the past for many traders we assume that they will work in the future.

Technical Analysis vs Fundamental Analysis

While we now understand what technical analysis is, let us define fundamental analysis and compare the two trading styles.

Trading with fundamental analysis is using economic indicators to predict the direction of growth, inflation and interest rates in order to determine their impact on financial prices.

We now briefly compare trading using technical analysis or fundamental analysis since some traders fall into either a single style and some use both.

Technical Analysis

Fundamental Analysis

focus is on market/price action

focus is on economic indicators determining prices

study of effect of price action

study of cause of price action

known/expected fundamentals are already discounted in the price, prices are now waiting to reflect unknown fundamentals

equilibrium price is reflecting known fundamentals, if price is above sell, below buy. The “why” is very important in fundamentals

Timing is crucial in technicals. Not just important to get the market reading right but also important to get the entry, exit right. Small margin requirements may force a player to get stopped out.

focus on analysis. Zero knowledge on timing.

can trade in any markets – JPY, GBP, CHF, THB with same concepts and across instruments such as FX, stocks, bonds, commodities, futures etc. Even chart fundamentals.

Huge knowledge investment for trading in different markets – would need to be familiar with different economies.

Different time dimensions – tick, minute, hour, day, week, years

tend to focus on long-term direction

Roadmap for Beginner Traders

Many traders start trading with technicals but also have a good working knowledge of the fundamentals. This is because when traders try to predict the future prices you will also need to know what economic data the market is awaiting the next week/month, what the expectations are and how prices will react to it. Trading on pure charts with zero knowledge of fundamentals is like trading half blind.

You can watch the free training video here

Begin the Basics of Technical Analysis here with the Dow Theory or fast-track your learning by joining the Beginner to Advanced trading course.

“Market Analysis can be approached from either direction (Technicals or Fundamentals). While I believe that technical factors do lead the known fundamentals, I also believe that any important market move must be caused by underlying fundamental factors. Therefore, it simply makes sense for a technician to have some awareness of the fundamental condition of a market.”

– John J. Murphy, Technical Analysis of the Futures Market

 

Related Topics

Chart Types

Trends

Support and Resistances

Trendlines – Best Practices

Continuation Patterns

Head and Shoulders Reversal Pattern

Academy – Fast Track to Becoming an Advanced Trader

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