What is Technical Analysis?
Technical analysis is a method of price forecasting based on prices mathematic calculations in the past. This is the analysis of prices and charts time series. This method was created for gaining profits in stock market game and in markets of stocks, assets and then in futures markets. All technical analysis methods were created separately and only in 1970s they were united in a single theory with a single philosophy, axioms and basic principles.
Technical analysis is the method of prices forecasting by monitoring market movement charts for previous periods of time. In other words, technical analysis does not consider reasons why prices change their direction (e.g. after stocks low yield or other prices change), but it considers only the fact that a price is already moving in a certain direction.
The term “market movement” stands for three basic types of information: price, volume, and open interest.
The price is a real products price at stock markets or is a currency index rate. All the information influencing product price is considered in the very price and in trade volumes and there is no need to study price dependence of political, economic and other factors. It is enough to study price/volume dynamics and to get information about the most possible market development. The history of technical analysis states that in many situations price increases non-interruptedly and its decrease is bouncing (after opening short-term positions). As business volume includes both transaction to buy and to sale, the price fixed after the trade termination does not depend on trade volume. The number transactions and the final price are not connected.
Trade volume is the number of positions that are not closed before the trading day (transaction volume or trade volume) measuring unit for trade volume is national currency. Not all of the three technical analysis indicators are the same. The major is the price, then it comes the volume and the last one is the open interest. According to the historical facts price changes reflect rather stable psychology of market crowd – participants’ reaction to similar situations is identical. However trade volume even in combination with price change can not display market demand and offer. The study of trade prices and volume is necessary for gaining experience in realizing transactions at stocks market. The general rule is the following: demand and offer set price and it is confirmed by volume.
Using technical analysis in practice implicate existing of certain axioms.
Axiom 1. Market movement is considered by everyone.
The essence of this axiom is that any factor influencing price (e.g. market product price) – economic, political, and psychological – is considered beforehand and is reflected in its chart. That means that there is corresponding change in outer conditions after any price change. For example in forex it is stated that if demand exceeds offer, the price rises. Technical analyst makes the counter conclusion – if the price on product rises the demand exceeds the offer.
Axiom 2. Prices have certain direction.
This hypothesis was the basis for creation of all technical analysis methods. The technical analysis aim is trade determination (i.e. direction of prices movement) for using while trading. There are three types of trends – bullish (price rising), bearish (price falling), and sideway (price stays almost unmovable). All the three trend types are not distinct as the “straight” movement may not be often encountered. But prevailing trend within a certain time period can be determined. All technical analysis theories and methods are based on the single-direction trend movement unless it signals about the turn.
Axiom 3. History repeats itself.
Analysts suppose that if certain analysis types worked in the past they will work in the future as well as this process is based on the stable condition of human psychology. However the possibility that the situation will be the same is excluded hence the axiom’s essence is only the axiom.
In favor of technical analysis as the instrument we have such characteristics as broad view and flexible way of thinking that are not peculiar to fundamental analysis and they allow many market participants reach the aim – to distinguish market direction. Technical analysis is the instrument that helps abandon trade position in time. However, unfortunately it is impossible to exactly predict anything. Prices charts work excellent describing past situations. But technical analysis of prices charts in the past does not always make it possible to guess turn points (changes in prices movement direction) in the future. Technical analysis is worthwhile when prices repeat situations in the past – trader psychology is directed on “buying and holding”. It is hard to imagine the profession of fundamentalist working with securities, currencies, and sugar at the same time or making day and year forecasts with the same easiness. But technical analysis is not that simple as well, for its effective use you will need high professional skills including skills to choose correctly the proper method.
