What is Technical Analysis?

What is Technical Analysis

Markets are volatile. However, that doesn't mean,one cannot profit from stock markets or any financial market for that matter. This is because there are methods for almost every aspect related to markets. For example, you can read historical market data to analyze trends and then forecast upcoming direction of prices. You can also study price and volume transformations without factoring external drivers such as news events. This is exactly what Technical Analysis empowers you to do.

Technical analysis attempts to measure the collective investor psyche, based heavily on the cycle of greed and fear. All financial markets are driven by supply and demand. Shifts in supply and demand cause reversals and these reversals can be detected on the charts with the help of Technical analysis.

Technical analysis traces its roots back, at least 100 years to Charles Dow, an American journalist who was probably the first man to observe that market moves in waves which eventually gave rise to the famed Dow Theory which is the basis of virtually all modern Technical analysis studies. Charles Dow is considered the granddad of Technical analysis and was also responsible for first toying with the idea of averages (market index) which gave birth to the Dow Industrials & Dow Transportation indices as they are known today.

Technical Analysis is primarily based on three principles:

  1. Market discounts everything
  2. Markets trend.
  3. Market moves in waves and history tends to repeat itself

These concepts are as valid today as they were about 100 years ago. Knowingly or unknowingly, traders have been using ‘Technical Analysis’,TA,in one form or another. Over the past 30 years, thanks to computers and the Internet, TA has been included in some of the most sophisticated trading systems.

Technical Analysis also boasts of advanced yet complex theories like Elliot Wave and Fibonacci Ratio Analysis, which allows a trader to pinpoint & project accurate reversal levels. In fact, with thousands of mechanical trading systems and algorithms now in the fray, most trading and investing systems incorporate some or the other dimension of technical analysis.

Dimensions of Technical Analysis
Price Analysis

It is the backbone of Technical analysis and deals with finding a location on the chart through the study of support and resistance levels. Tells you ‘Where to Buy’.

Pattern Analysis

Deals with the form of price action and finds repetitive patterns that show up on the charts like Triangles, Rectangles etc. Pattern analysis also includes the sophisticated yet complex Elliot Wave Theory.

Trend Analysis

Trend following is considered the finest strategy in all of financial markets. Interestingly, the Trend is central to the study of Technical Analysis and offers a variety of tools and theories specifically designed for trend identification.

Momentum Analysis

Momentum indicators & oscillators are created from the manipulation of price data & they help in supporting or rejecting the price trajectory, offering hidden signals of reversals. Moving Averages, RSI, Bollinger Bands, Stochastic, MACD, etc. are the most frequently used indicators.

The principles of technical analysis are derived from hundreds of years of financial market data. It can be applied to stock markets, indices, commodities, futures, options or any tradeable instrument where the forces of supply and demand influence the price.

Only 2 schools of thought in financial markets - Technical Analysis & Fundamental Analysis

A fundamental analyst computes the fair value from the financial data of the company, converts them into analytic ratios like the PE, EPS, BV, among others. While fundamental analysis excels in stock selection primarily in the long term,it has a poor track record with respect to timing and risk management. This is because it depends on data mining, varying perspectives and complex macro and micro factors. This can be seen from the fact that different investors react differently to the same news.

However, markets turn before fundamentals do. That is where Technical Analysis,TA,scores higher. This is because a single chart displays all the areas of price action. It studies how traders are reacting to news and data and follows the footsteps of smart money. It is ideal for managing risk and foreseeing dangers & opportunities. An expertise in trend combined with support and resistance analysis alone is generally good enough to trade successfully.

Overall, Technical Analysis is simply put...Easier and Faster than Fundamental Analysis.