Technical analysis is a method of forecasting prices based on information about market quotes, volume and open interest.
The main of these three components is the price. The study of prices by methods of technical analysis is most convenient, since information about the price, as a rule, is publicly available, has a long history.
Note: in the Forex market, technical analysis uses data only on prices and tick volume (the number of quotations), since data on actual volumes are not available, and open interest is not calculated.
The technical analysis differs from other types of research also in that it is based on mathematical, statistical, and not economic calculations. All methods of technical analysis were developed separately, so there is no strict system, there is only a set of methods or techniques, from the simplest (graphical analysis) to supercomplex (for example, neural algorithms). Moreover, often different separate methods of technical analysis contradict each other. The only thing that connects these individual techniques is the general principles and axioms.
Technical analysis is based on three postulates, which are also sometimes called axioms.
1. The course took into account all the factors that affect it.
In classical (factorial) analysis, it is assumed that the exchange rate is formed as a result of the action of supply and demand for the currency, which depends on a large number of factors (economic, political, psychological or other, as well as their interrelationship). If the demand for currency exceeds supply, then the rate increases, if on the contrary, it falls.
Technical analysis (TA) changes the cause and effect in places and says: if the rate increases, then demand exceeds supply, if it falls, then vice versa. Thus, TA argues that since all factors are already present in the price chart, there is no need to study them. There is a price history, and it is enough to predict the future.
Fundamental factors do not influence the price independently but through the opinions of buyers and sellers. It is clear that how many people, so many opinions (and in this case, expectations, forecasts and actions), so the only objective indicator is only the actual price and volume of trades. Price is an opinion that everyone has already expressed, so even if the factors influencing the opinions of investors have changed, it does not matter as investors have already taken action and changed (adjusted) the price. The market has already been “pawned” (dealer jargon) under the fundamental factors.
By this statement, TA differs from another kind of analysis – the fundamental one, which asserts that the price depends on supply and demand, and hence on a large number of factors. According to the fundamental analysis, by forecasting these factors, you can predict the price.
Technical analysis has become particularly popular in connection with the development of the theory of market efficiency (Efficient Markets Theory / Hypothesis), which claims that using analysis of fundamental factors (in the jargon of the “foundation”) it is impossible to obtain a yield above the market average.
Like any analysis system, TA is not without its shortcomings. Usually, the criticism of the first postulate goes on two points.
- In the market there are “shocking” (in the sense of unexpected) news that investors could not predict: the speeches of officials, the actions of central banks, natural phenomena, etc. (although it is worth noting that fundamental analysis here will not help, because the unexpected news is unexpected for everyone).
Not all investors receive information at the same time. Someone is trading in the short term and watching the news online. Someone analyzes daily or even weekly charts and learns information from newspapers.
- Price movements tend to be believed that one of the basic concepts in technical analysis is the notion of trend or trend. In technical analysis it is believed that the market is always subject to one or another trend, and the continuation of the existing trend is more likely than its change. Therefore, the main task of the technical analyst is to identify, at early stages, the termination of the old and the development of new trends.
There are three main types of trends:
- The upward trend (up closeup Trend) – upward price movement, it is sometimes called a bullish trend (bullish Trend) ;
- Downward trend (down Trend) – the price movement down, sometimes called bearish trend (bearish Trend) ;
- Sidetrend (sideways – outset, trading range – trading range) – the price is practically not moving.
All three types of trends are not found on the market in pure form.
There are a huge number of methods that determine the type of trend present at the moment in the market. One of the simplest and oldest is the Dow theory. According to Dow theory, there is an upward trend in the market if each subsequent peak (local maximum) and each subsequent decline (local minimum) is higher than the previous one. On the contrary, the market develops a downward trend, if each subsequent decline and each subsequent peak is lower than the previous one. A lateral trend exists when none of the above conditions is met.
The most frequent criticism of the postulate is that it is simply trivial. If the prices are in motion, then they can not move anywhere, and therefore have a tendency. Thus, the postulate states that the water is wet.
3. History repeats itself.
This, perhaps, is the main postulate of technical analysis and if it were not there, TA would not make any sense. It is believed that the psychology of both the individual and the crowd varies from year to year insignificantly, its basis remains. The crowd of investors in similar cases takes similar decisions, which means that if any scenarios have worked in the past, then other things being equal they will work in the future. Therefore, the key is understanding the future movements lies in the price history.
Thus, technical analysis is a kind of set of mathematical and statistical methods of studying human psychology, expressed in price.
The most frequent criticism of the postulate is:
- The situation “with other things being equal” does not exist in nature.
- The market is a self-learning reflexive system. Therefore, if traders saw that event “B” occurs after the specific event “A”, the next time after the event “A” they will make market decisions, express them in price, change the causal relationship and get the “B +” event as a result. In the next cycle, traders will see that event “B” or “B +” occurs after the “A” event and will make other decisions.
- Methods of technical analysis themselves affect the market because it is through them, indirectly made decisions about buying and selling.
Advantages of technical analysis.
- Technical analysis is equally applicable to different types of markets. Trends in the market of grain or orange juice can also be studied as trends in the market of currencies or government bonds.
- Technical analysis does do not require such a large amount of expensive and diverse statistics, as required, for example, fundamental analysis. All that is necessary for him is a price history for a specific trading instrument for a sufficient period. This price history and the technical means (software) of its analysis are generally available and free of charge.