What is technical analysis
What is technical analysis
Updated 18.02.2022

Each trader wants to know in which direction the market will go. Actually, that is the essence of trading assets – to predict the market movement and receive profits from it. And to be able to understand the trends that may help you earn money, the ability to conduct technical analysis is required. Here, we will tell you what it is, why it is needed, and why each trader should be familiar with it.

A bit of context

In its simple forms, technical analysis (TA) originated during ‘Tulip mania’ in Amsterdam, back in the 16th century, at the dawn of exchange trade. But a key contribution to its development was made by the economist Charles Dow (who also established the well-known Wall Street Journal). It was he who noticed that the price movement in the past could be analyzed, which allowed to forecast the trends of assets in the future. A whole Dow Theory was formed that marked the beginning of the market technical analysis.

Here we must make a remark on how it differs from a fundamental analysis that is often confused with TA. FA takes into account many factors affecting the price, while TA concentrates on the charts of a price change within a specific period, omitting other details. Thus, you define the tendencies and possibilities that may be used for trading.

How does ТА work, and what’s its use specifically? 

As we have stated before, studying the prices, both preceding and current ones, plays a key role in technical analysis. It is based on a simple idea: any fluctuations of the asset price (in the long-term perspective) aren’t accidental. A tendency and regularities of development can be found everywhere.

It is clear that the asset price is tightly connected to the balance of supply and demand on it – that is a fundamental principle of the work of the market. But here also the emotions of big players are present: jealousy, fear, and mistrust. They may break the accuracy of technical analysis. That’s why it works best on huge markets with high liquidity, where fleeting concerns of individual investors cannot break all the calculations.

To study the prices, traders use various indicator tools, using which it’s possible to build relevant charts. The more indicators there are, the more accurate and reliable the analysis will be. The chart that you receive eventually will provide you with an approximate trend evaluation that the price of the asset will follow.

What indicators should be used for quality TA? 

Let’s repeat: the best option is to use several indicators to make the results more accurate and be less reliant on contingencies and news. Most often in technical analysis use simple moving averages (SMA). They are calculated based on the price that the asset had at the time of its closing. Sometimes a modified version of the indicator – EMA – is used that considers more new deals.

The second popular indicator is RSI, a relative strength index that refers to oscillators. Simple moving averages evaluate the changes of prices over time, while RSI applies specific formulas to these price changes, getting an index of 0 to 100. One more frequently used oscillator is Bollinger Bands, used to evaluate the market volatility.

There are lots of various indicators and oscillators for technical analysis; however, it’s too inconvenient and costly to apply all of them. That is why you need to choose those that fit your specific task. Ask yourself: ‘what do I need from the technical analysis?’, and after that, pick the necessary indicators.

Does technical analysis have any pitfalls?

Many trading experts actively criticize TA, calling it a ‘self-fulfilling prophecy’. That is if the whole market believes that some stocks will grow and starts to actively purchase them, the stocks will actually grow, but not due to a correctly conducted TA, but because traders believed in this analysis. Besides that, many indicators of technical analysis generate ‘false signals’ – noise that prevents correct evaluation of trends. That is especially actual for cryptocurrency markets where the volatility is high, and indicators sometimes cannot predict asset movement.

Anyway, although TA is efficient, you shouldn’t rely on its conclusions 100% since similar, baseless in reality predictions may be made by other traders, thus, the price will grow/fall, but after that, the market will reverse to its real trend.

Isn’t it better to use fundamental analysis instead of TA all the time? 

Like we’ve mentioned before, instead of a price chart, fundamental analysis analyzes a wide range of factors that may affect the asset. This tool is widely used, for instance, to evaluate the company’s value and its perspectives because the price of stocks within a long period doesn’t reflect the whole picture that investors really need. Also, FA is used for long-term investments: in this case, it should answer the question: ‘Is the asset overcharged? Does it really have perspectives, or is it valued at the whim of a market?’.

In fact, both tools are required for their specific situations. It’s not smart and efficient to conduct fundamental analysis before day trading. Besides, TA has an undeniable benefit for such deals – it evaluates actual quantitative indicators instead of trends that are useless in the short run.

A lot of things also depend on a trader conducting TA. Conclusions may include emotions, personal beliefs, or a wrong evaluation of a situation upon objective data. As a result, traders need both fundamental and technical analysis: but they need to be applied under different circumstances.