Ehe technical analysis is a branch of study used to anticipate the future direction of quotes by studying historical market data. To achieve this, this technique makes use of data referring to the prices, volumes and open interest of a market.
This means that the Technical analysts use trading data along with mathematical indicators to make their trading decisions.. The result of these formulas is automatically reflected in a graph that is updated in real time, which will be interpreted by the traders to determine when to buy or sell.
Thanks to the technical analysis it is possible to predict the direction of the quotes, which has made it one of the main tools for predicting the behavior of financial markets. The latter is especially true when technical analysis is combined with fundamental analysis. The union of both types of analysis allows traders to have a more complete assessment of the reality of the market. Thanks to this, traders can obtain a clear advantage when carrying out trades with benefits.
Duality between technical and fundamental analysis
In the market study, the two most widely used analysis tools are technical analysis and fundamental analysis. Technical analysis originated in the United States, in the late XNUMXs. Its creator and main exponent was Charles Henry Dow, creator of the Dow theory. The purpose of technical analysis is to identify trends or patterns, through them, allow traders to make action decisions within a market. To achieve this, technical analysis uses a series of graphical and mathematical tools to predict these trends and make a decision.
Furthermore, the fundamental analysis, is a tool initially developed by Benjamin Graham y David Dodd, in 1934. The idea of fundamental analysis is that of calculate the value of an asset using the data provided by the balances of those assets and comparing them with what is observed in the market. With this, it seeks to provide the best visualization of an action to the trader and allow it to take a position against said action.
The purpose of both tools is the same: offer a market analysis tool to traders so that they make the best possible decisions at all times. Something that without a doubt both tools perform successfully.
Principles of technical analysis
Technical analysis has a series of pillars that support its validity. When Charles Dow developed his theory, he summarized those principles into the following:
- The price discounts everything. This is the most important principle of technical analysis. This principle indicates that; all information is included in the price. That is, political factors, wars, reports of benefits of a company, social situation of a country. Everything is discounted in the price. This means that all that local or global action that may have an impact on a certain value will be reflected in its price.
- Markets are trending. This is a situation that occurs at all times and without exceptions. Trends can be upward, downward or lateral. Charles Dow explained that, an asset is trending until you prove otherwise. This means that; until the reference maximum or minimum is not exceeded, the trend of that value continues.
- Human behavior is repetitive. Human psychology is predictable because its mass behavior is cyclical and responds in the same way to similar events throughout history. Under this precept, the technical analysis affirms that; patterns in prices are unconsciously created that reflect this behavior. Thanks to that, their study allows us to predict future price movements since they are affected by the psychology of the group related to it.
Origin of technical analysis
Technical analysis had its origins in the United States, in the late XNUMXth century. Its creator and main exponent was Charles Henry Dow, creator of the Dow Theory. This theory gained great momentum with Ralph nelson elliott within the stock markets with its Elliott Wave Theory, and later it was extended to the futures market. However, its principles and tools are applicable to the study of the charts of any financial instrument.
Technical analysis can be subdivided into two categories:
- Chart analysis or chart analysis: exclusively analyzes the information revealed in the graphics from geometric figures mainly, without the use of additional tools.
- Technical analysis in the strict sense: it uses indicators calculated based on the different characteristic variables of the behavior of the analyzed values.
Robert Rhea, a renowned market researcher, explained very simply what a technical analysis is:
The fluctuations in the price of the Dow Jones shares of railways and industrials is like a composite index of all the hopes, disappointments and knowledge of everyone who knows anything about financial matters, and for that reason the effects of events. futures (excluding the acts of God) are always anticipated in their movement. The indices quickly assess both calamities and fires and earthquakes.
Robert Rhea - "The Dow Theory" - New York, 1933.
Technical analysis tools
This is the most widely used type of chart for visualize and analyze price movements over time for securities, derivatives, currencies, stocks, bonds, raw materials, etc. They are also known as Japanese candle chart, as it originated in that country. Candlestick charts display various pieces of price information such as the open price, the closing price, the highest price and the lowest price through the use of candle-like symbols.
These represent compressed trading activity for a single period of time (one minute, hour, day, month, etc.). Each candlestick symbol is represented along a time scale on the axis x, to show commercial activity over time, while the axis y it is used to represent the price. They are especially useful thanks to their versatility and their utility to detect and predict market trends over time.
The charts are one graphic representation used to organize the information contained within a market. In general, the financial and cryptocurrency markets use bar charts or line charts, to represent the live flow of a security within a market. The reason behind the use of these graphic tools is synthesize as much information in a single box, allowing a better understanding of said information. Charts are often used to facilitate understanding of large amounts of data and the relationships between parts of the data.
This is very useful in a financial market where information on the value of shares changes rapidly and the flow of data is constant.
Technical indicators are statistical-based tools to determine future market behavior. These are the four general categories of indicators:
- Trend- These indicators are used to detect trends in the financial markets. This group of indicators is inefficient for periods of equilibrium (Flat) in the market. Trend indicators indicate the direction of price movement.
- Momentum: This is an oscillator-type indicator that shows the trend of the prices of an asset and the changes it has had in a certain time. Its function is to anticipate trend changes and teach the speed of change in prices. The exercise consists of observing the difference in prices between the closing of the current period and that of days before.
- Volatility: These indicators analyze changes in market prices over a specific period of time. The faster prices change, the greater the volatility and, conversely, the slower, the lower the volatility. It can be measured and calculated on the basis of historical prices, as well as to identify trends. It also usually indicates whether a market is overbought or oversold (meaning the price is unreasonably high or low) and may point to a stagnation or trend reversal.
- Volume: these are used to study the volume of a market, allowing the evolution of volume to be related to changes in the price.
Technical drawing set
Another of the tools widely used in technical analysis are the technical drawing techniques. Technical drawing is a form of drawing that serves to bring a group of data to a graphical representation, in order to transform them into a descriptive graphic representation. With this, traders seek to facilitate the understanding and analysis of market charts.
These tools are widely used in technical chart analysis, where we can see it represented in graphs such as the linear graph, bar graph and the candle graph.
Advantages and disadvantages of technical analysis
One of the main advantages of this tool is the Ability to identify signs of price trends in the market. This is a key factor in any operational strategy when conducting operations. Thanks to this, investors are able to develop a sound methodology, aimed at locating entry and exit points in the market.
Another of its advantages is that technical analysis tools they are very common and easy to use. In fact, they are so common that there are those who believe they have created self-respecting operating rules: The more investors use the same indicators to find the levels of support and resistanceThere will be more buyers and sellers interested in the same price points, and patterns will inevitably repeat.
One of the main disadvantages of this tool is that There will always be an element of market behavior that is unpredictable. This situation is closely linked to the Random Walk Theory, Presented by Louis Bachelier in 1900. This theory indicates that:
"Any change or evolution existing in financial markets is not measurable and estimable, due to their randomness and efficiency. It also points out that it is not possible to make reliable predictions of the price of assets only by studying their past evolution ”.
It is because of that there is no guarantee that an analysis type is 100% correct. Although historical price patterns can give us an idea of the possible trajectory of an asset's price, this is not a guarantee that it will happen.
Investors should employ various indicators and technical analysis tools to achieve the highest possible level of security and have a risk management strategy in place to protect themselves at unfavorable times.