Technical analysis is a way of analyzing the markets. It does that by examining the price and the volume using historical data.
Technical analysts believe that all fundamental factors that could influence the price of a certain asset are already reflected in that price and that in order to predict future moves, one has to look no further than the price action itself. Technical analysis is based on several underlying assumptions when it comes to evaluating a financial market.
History always repeats itself.
Prices move in a cyclical manner, so identifying these cycles and certain features within them can give useful information on what to expect in the future.
Prices are trend driven.
These trends can be short-, medium-, or long-term, but there will always be a prevailing team, either the bulls or the bears. It is not unusual for the trend to be interrupted by pullbacks (moves in the opposite direction), still a price move that has gained momentum is more likely to continue its path. A slowing price move, on the other hand, is more likely to reverse.
Techical analysis relies heavily on statistics.
It attempts to understand the market by looking for different patterns. It focuses on price and volume of the trading asset, rather than financial statements, labor market and inflation.
There are two different approaches when doing technical analysis – top-down and bottom-up. The top-down approach would start form the “big picture” of the asset. A trader would first identify a good trading opportunity on a larger-scale chart and then work his way down to pinpoint the exact entry level for a trade. This approach is often used by short-term traders.
The other way is the bottom-up approach. It involves identifying a good trading opportunity on a small-scale chart, then going up-scale to evaluate the potential of the trade. The bottom-up is mainly used by investors looking for longer-term positions.
Some argue that technical analysis is more a kind of a self-fulfilling prophecy, since it is so widely used, rather than it is analysis, and that technical rules work, because so many people are using them to place their orders.
On the other hand, technical strategies are so diverse, that it is hardly possible for all traders to follow the exact same logic at the exact same moment. Technical analysis has proven its worthiness and, together with fundamental analysis, help to understand and evaluate the financial markets.
