How does Technical Analysis work?

Once, between the adherent of technical analysis and the fundamental investor, a dispute arose over the operability of technical analysis. The fundamental investor sent his opponent a line chart and asked to predict the movement of the market. He did not provide any more information. Was it an action , an index, a raw material or some other asset ? Was it a tick chart, minute, hour, day, week or month? Perhaps it was a randomly generated line on the chart? A trader practicing the use of technical analysis replied that the market, probably, will continue to do, what does (and he at that moment grew up), but may fall. How did he know what would happen the next day with the line on the chart? Perhaps in this way the investor wanted to prove to himself that technical analysis does not make sense. But this he did not prove anything. He just asked the wrong question and got nothing meaningful answer.

As Edward Denning said, “If you do not know how to ask the right question, you will not find out anything.” What should be the correct question? Albert Enstein, who once wrote: “If I had one hour to solve the problem, and my life depended on it, I would have spent the first 55 minutes on the correct formulation of the question. Because, as soon as I correctly formulate the question, I can solve the problem in less than five minutes. “

It is very important to know what the technical analysis suggests in one or another. Before a trader can confirm or disprove his hypothesis, he must first understand whether his underlying assumptions are true or false.

What is technical analysis?

Technical analysis is based on information about price and volume, correct interpretation of this information can predict the changes in the direction of price movement with high probability. Specialists in technical analysis use graphs as a visual representation of price movement. Before computers were widely distributed, traders had to look at the print ribbon to draw the same information, and draw the charts themselves. However, do not forget that the fundamental factors are often reflected in the graph. Sometimes the price movement lags behind the fundamental factors, so in this situation, the price will continue to move even after the fundamental factors change. In other cases, fundamental factors can exert a leading influence,

Each bar on the chart is the culmination of the opinion of millions of market participants and, accordingly, the formed demand and supply. Participants entering the market express their opinion about the direction of the asset in the future, and the price of the asset moves in one direction or another. They buy, if they believe that the price will rise, and sell, when they believe that the price will fall. If they do not have a definite opinion, the price, most likely, will not move or will be in lateral movement. The technical analyst is not interested in why the market participants came to this opinion. He’s just trying to figure this out by looking at the chart. Therefore, technical analysis studies the behavior of the market, which is reflected in price and volume.

Studies show that people act reasonably predictably when they find themselves in similar circumstances. The market is growing and falling due to certain psychological prejudices and reactions of market participants. History can be repeated, but not with 100% accuracy. Therefore, the technical analyst should be judicious, trying to form an opinion on the future direction of the price movement. With that said, technical analysis is more of an art than a science. The price chart, most likely will not tell the trader anything, if there is no context and additional information about the intentions of market participants. Technical analysis is a tool. But no instrument, fundamental or technical, can accurately model and predict what will happen in the market, it can only help increase the chances of opening a successful transaction. Trading is a game of probabilities, so when opening a deal, you need to use all available methods and means to get the odds on your side.

How to use technical analysis?

Having dealt with what is a technical analysis, you need to decide how to use it. Do not look at the chart, try to predict what the market will do the next minute, the next day, a week or the next month. This is silly. The correct question that a trader should ask when looking at a chart is simple enough: “What is the market doing at the moment?”. We need to forget about the predictions, look at the chart and try to see what he says about the behavior of the market directly at this moment. Looking at the history you need to evaluate what the market has already made to date. Is it in an upward or downward trend, or in a lateral movement? It is necessary to study the graphs, trying to find the key to the market movement. For example, is there a series of highs on the chart, each of which is higher than the previous one? Are there any previous highs on history that can serve as resistance? How strong is the trend? Were there significant retracements? And so on.

Reading a schedule is skill. As in any other case, in order to learn to read graphics, you need time and practice, otherwise you will not be able to apply this skill correctly. When a trader has read what the market says, and not what he should say, then an opinion is formed about what is happening, and an appropriate decision is made whether to open a deal for purchase, for sale or for the time being to refrain from trading. From the opening of transactions should always be abstained, when there is no understanding of what the market is doing at the moment. Before taking any action, you need to wait until the market tells you what it does.

In order not to commit ill-considered actions and not waste money before entering the position, it is necessary to answer to yourself not three questions:

– When did the market signal?

– When did the market confirm this signal?

– What should happen to misunderstand me?

For example, if the stock retreated from the resistance level, it could serve as a signal. You can wait until the price comes back and the second time bounce off this level of resistance. This price behavior will confirm that the level is held and its penetration is unlikely. When confirmation appears, you can open the deal in short. The market will report that the decision is wrong if the price goes back up and pits the resistance level. When opening such a transaction, you can set a stop order above the resistance level, so that the loss was small and controlled.

Does the technical analysis work?

The answer depends on who uses it. Any tool will be useless if it is in the hands of someone who does not know how to use it. Jesse Livermore , the legendary investor who used his technical analysis skills in trading when reading the tape, said: “If you have a minute, I’ll tell you how to make money on stocks.” Buy at a minimum and sell at a maximum. “If you have 5 or 10 years, I will tell you how to understand when the stock is at a minimum, and when at the maximum. “

The truth is that trading is a difficult activity, but not in the sense that many people understand it. Recently I read an article on the Internet criticizing technical analysis. One of the arguments was that the largest institutionalists employ the most intelligent people in the world with academic degrees to trade using the best quantitative strategies. In the light of such a statement, it would be foolish to consider that a private investor can win in the fight against such intellectual power. Perhaps the first statement is true, but the second is not very. Starting trading, the trader slowly begins to understand that it is necessary to watch, fear and control not so-called geniuses of quantitative analysis, but a much more insidious opponent, and this opponent is the trader himself. The trader constantly has to fight with himself. He is a market, he is predictable, he succumbs to two enemies – fear and greed – at the most inopportune time. It is he – the reason that well-trained specialists of technical analysis can read on the chart the behavior of market participants. It is because of this predictable behavior, which is inherent in human nature, that certain patterns are formed on the graphs.

Therefore, the greatest difficulty for each trader is his natural essence, and victory over it will be his greatest achievement. That’s why the way to becoming a trader is through mastering oneself. which is inherent in human nature, certain patterns are formed on the graphs. Therefore, the greatest difficulty for each trader is his natural essence, and victory over it will be his greatest achievement. That’s why the way to becoming a trader is through mastering oneself. which is inherent in human nature, certain patterns are formed on the graphs. Therefore, the greatest difficulty for each trader is his natural essence, and victory over it will be his greatest achievement. That’s why the way to becoming a trader is through mastering oneself.

Happy ignorance

Many trading systems that promise quick wealth are based on certain technical principles. The only thing they can really do in just three days or a few weeks, or even a few months, is to give an understanding of some of the basics, such as graphic models. Possessing such knowledge, a trader becomes a more dangerous rival for himself and his portfolio than someone who does not know anything, because now he is armed with a false sense of competence. He thinks he has the knowledge, so he throws himself into the market with his head, but his money flows into the pockets of those players who really know what they are doing.

Therefore, the correct answer to the question “Does technical analysis work?” – it depends on who was asked the question. If the question is addressed to an experienced trader (professional or private) using technical analysis as a tool, the answer can be positive. And if the question is answered by someone who has just learned the word “trading”, then it can be negative.

Related posts