Technical analysis is the most effective trading tool. In this blog we are going to learn about
History has shown that, when used properly, it can bring in enormous profits for traders.
Table of Contents
- What is Technical Analysis?
- Why Does It Work?
- What are the differences between fundamental analysis and technical analysis?
- The Top 3 Misconceptions Around Technical Analysis
Charles Dow, recognized as the founder of technical analysis, invented it in the late 1800s. He was the first to recognize the link between previous price movements and their impact on future price direction.
His observations on recurrent price patterns that repeat themselves again created the cornerstone of technical price movement analysis.
Dow Theory is a collection of works by Charles Dow that is still popular among traders.
What is Technical Analysis?
Technical analysis is the study of historical price data.
There are many different types of research, including quantitative, pattern, and geometrical methods.
The fundamental goal of technical analysis is to establish a link between past price data and how it will affect current prices in the near future.
Technical analysis places a strong emphasis on the idea that the price itself reflects all information that is current at the time of analysis.
Price, hence is a psychological reflection of market participants.
Although technical analysis is the most crucial component of successful trading, there are other skills needed as well, as we will discover in the later sections of this blog.
Why Does It Work?
Whether in trading or another type of business
Why should this work or how will this work should be the first question one asks in every situation.
Since charts represent everything that has occurred previously, they are a good place to start when trying to find an answer to this question.
Let’s first examine the participants in the action before delving further into its specifics.
- Big hedge fund managers
- Big financial institutions (with high-end computer programs and high-frequency systems)
- Retail Traders
Now all of these market participants place orders in the market by looking at historical price data.
Keep in mind that whenever prices enter the green rectangle-depicted price band, they rise.
This is because the reference price memory of all market participants.
Buyers remember when prices first appeared in this range of prices, when buying began, and when prices increased.
Therefore, whenever prices rise in this region, everyone starts to buy, driving up prices.
Historical price movements also create recognizable patterns, which help identify trading opportunities for the future.
What are the differences between fundamental analysis and technical analysis?
Let’s now examine the distinctions between both types of analysis.
Technical analysis makes the assumption that all available market data is reflected in price, whereas fundamental analysis studies the economic factors influencing price changes.
While TA only uses historical prices to forecast future price direction, fundamental analysis focuses on the performance of a company, industry, or the global economy.
While traders have short-term goals and favor chart analysis, investors use fundamental analysis for long-term investments.
TA is more concerned with “when” prices will change, whereas fundamental analysis concentrates on “Why” prices change.
Technical analysis requires knowledge of concepts related to charts, whereas fundamental analysis requires an understanding of various economic and financial market components.
The Top 3 Misconceptions Around Technical Analysis
I discovered there are many paradoxes that exist when I started paying attention to my trading.
All paradoxes have price analysis at their core, and I’m going to discuss the top 3 of them here:-
- Sure Way Of Predicting Future
The degree to which forecasting price movements is relied upon is the reason why trading attracts so many traders.
After years of trading, many profitable traders come to the conclusion that they cannot predict the future.
What they can do is use the analysis to improve their chances of success.
Thinking in terms of probability and looking at the above example shows us how the probability of prices moving higher or lower increases with each bounce inside the trading range.
High probability zone breakouts give us advantaged trading opportunities.
However, in no way should these zones be taken into account as a foolproof method of forecasting future price movements.
(I have given several examples of how to improve winning probability in chart patterns, if you want to look click here)
2. Enough for consistent profitable results
The second most typical fallacy is that technical analysis is the key to consistently making money in trading.
As a trader, you will soon realize that a variety of skill sets are responsible for the majority of your trading success. –
- Money Management
- Risk Management
- Trading experience
You can learn more about trading essentials and how important each of these trading elements is for success. Here.
3. Only for short term Traders
Another myth is that technical analysis is only used by short-term traders.
Positional traders, investors, actuaries, and behavioral economists all frequently use it.
TA is also a study of mass human psychology.
Its uses are becoming increasingly widespread in other spheres of the financial industry.
Technical analysis helps traders and investors make risk management decisions.
There are various benefits to applying technical analysis to different financial instruments.
Technical analysis remains a popular tool for traders, and its techniques are constantly evolving.
These days, “Analysis Paralysis” is a very common problem for traders, so it’s important to be aware of all the necessary skills.
However, my personal recommendation would be to give equal weight to all skills and develop your trading method. New traders spend too much time analyzing the markets and especially trying to predict what will happen next.
which includes every crucial trading tool, as well as any skill, would not be very helpful in achieving your trading objectives by itself.
Author is Senior Trading Analyst
At Bulls Arena Trading