Technical Analysis 101: The basics explained

15 June 2020

    When entering the world of trading, there are certain terms that an investor comes across sooner or later. Do fundamental and technical analysis ring a bell? Most probably yes. But what exactly are they and how important are they in trading? Today we will focus on technical analysis.

     

    So, what exactly is technical analysis?

     

    Simply put, it is a way of examining and predicting price movements of an asset, by analysing its chart patterns, trends and other factors. In the process of conducting their technical analysis, traders employ various tools and indicators in order to examine their selected instrument’s price patterns over time and try to predict how the asset is going to perform in the future. Technical analysis can be applied to any securities with historical price data, such as forex, shares, stocks, futures, commodities etc.

     

    Technical analysis, as we know it today, is dated between 1851 and 1902 and was introduced by Charles Dow and his famous Dow Theory. The Dow Theory was based in the assumption that a daily market move consists of an uptrend, a downtrend, a top and a bottom, and this basis is what forms today’s technical analysis. Technical analysts follow these exact principles by examining indicators such as a contract’s historical data, in order to estimate its future price direction.

     

    Key assumptions of technical analysis

         

    Today’s investors base their technical analysis on Dow’s theory, accepting three fundamental assumptions:

     

    1. The market discounts everything: Analysts believe that in technical analysis, factors such as a company’s fundamentals and market psychology, are already taken into consideration and priced into the stock.

    2. Prices move in trends: Technical analysis strongly supports that prices don’t move randomly, but they rather follow a trend. For example, a stock’s price is more likely to repeat a past trend than move unpredictably.

    3. History often repeats itself: Market psychology plays a very important part in this technical analysis assumption, due to the fact that emotions like fear and excitement do play an integral part in trading. Analysts look at markets’ past movements and decide when to enter or exit a trade in order to maximise any potential profits.

     

    And how is a technical analysis used?

     

    Well, technical analysis can be used in both long and short-term trading. Long term investors might decide when to buy or sell a stock, while short-term traders may identify quick opportunities to profit. Technical analysis is quite straight-forward and applicable to almost any market – all you need is a price chart and some technical indicators. So, whether you want to trade forex, stocks or cryptos, technical analysis can surely be of use.

     

    Now, you may wonder about the indicators we just mentioned. Indicators are one of the fundamental components of good technical analysis and fall into two categories: leading and lagging. Leading indicators aim to predict price movements and usually pinpoint price breakouts. Lagging indicators highlight and confirm price movements. In general, there are four groups of technical analysis indicators, with the most popular being Trend, Momentum, Volatility and Volume. You have surely heard of Moving Averages, the Relative Strength Index, Stochastic Oscillators or the On Balance Volume. Well, these are all different technical analysis indicators, which we have also analysed in a previous article, going into depth on the 4 most popular and widely-used indicators. Also don’t forget that you can see over 70 technical analysis indicators in action on Fondex cTrader. The platform provides you with in-built indicators, ready for you to use straight-away without the need to download them externally or use any special add-on service.   

     

    So, here comes the million-dollar question… Fundamental or Technical Analysis?

     

    As with most things in life, there in no right or wrong between the two. Both are the two major schools when it comes to analysing the markets, sitting at the opposite ends of the spectrum.

     

    Fundamental analysis is based on evaluating a market as a whole. Fundamental analysts study aspects such as the overall economic state of a country, specific industry conditions, as well as the state of a company, how financially stable it is, its earnings, assets, expenses and liabilities. For example, if a fundamental analyst chose to trade Microsoft shares, they would need to examine Microsoft as a company – reports, earnings, losses, you name it. And if this is not enough, they will also need to consider how the technology sector is performing before they decide on which market direction to follow.  

     

    In contrast to fundamental analysis, technical analysts focus on an asset’s price and volume. Technical analysis lays on the assumption that all fundamental aspects of a market are included in the price. So a technical analyst who wants to trade the same Microsoft shares will only need to look at a price chart, employ a certain number of indicators and predict the price direction.

     

    This example may be showing that technical analysis is easier than the fundamental one. This is not true by any means. Using indicators is quite tricky since one needs to decide which are the best ones first, and then optimize and back-test their strategy to make sure it is the best possible for them. And in truth, most traders use a mix of both fundamental and technical analysis, in order to have a more balanced view of the markets – fundamental analysis helps them decide which market to trade, while technical analysis predicts the best point to open their positions.

     

    Is technical analysis and trading a match made in heaven? Yes and no. In the positives, we have to acknowledge the fact that technical analysis can be quick. All you need is a chart, some indicators and you’re done. Trading platforms, including Fondex cTrader, give you the possibility to access indicators straight from the platform and also create your own, based on your strategy.

     

    On the other side of the pond, technical analysis can be subjective, meaning that two analysts may come to different conclusions. The fact that technical analysis also ignores the fundamentals, such as sudden news or company announcements, makes this type of analysis provide a limited view of the market. As you can see, there is no right or wrong. Each type of analysis puts different facts into perspective and serves a different point of view. Choices should be made after a thorough consideration of your strategy and what you wish to achieve. One thing is certain though; whatever the type of analysis, none of them can guarantee results. 

     

    So, there you have it! What type of analyst are you? Form your strategies and trade over 1000 assets on the best trading platform!

     

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