Traders and investors in finance use different methods to make smart decisions about securities.
Technical Analysis (TA) is a method of evaluating securities. It involves analyzing market activity statistics like past prices and volume.
The main idea of TA (Technical analysis) is that past prices can help predict future market behavior.
In this blog, by IBH (International Business House) we will explore the main ideas of technical analysis. We will discuss different methods and how trends can help with trading choices.
The Basis of Technical Analysis
Technical analysis is based on the idea that markets have patterns and behave in an organized way. These patterns can be predicted by looking at past prices. However, there are varying schools of thought on the effectiveness of technical analysis.
Strong Technical Approach
Supporters of the Strong Technical Approach firmly believe that past prices can accurately predict future outcomes. This view believes that models made from past data are always reliable and valuable, no matter what others say.
Negative Technical View
On the opposite end, the Negative Technical View contends that history is not indicative of future market movements. From this viewpoint, old prices are irrelevant. The market’s direction only depends on new information and events.
Weak Technical Approach
The Weak Technical Approach recognizes that technical analysis can help find trends and price points. Yet, it recognizes that new information can affect market behaviour, causing deviations from the predicted trends.
Agnostic Technical View
The Agnostic Technical View accepts that technical analysis may not always be accurate or predictive. Nonetheless, traders who agree with this idea may still use technical models. They expect others to follow these models, which can make them come true.
Three Principal Assumptions of Technical Analysis
1. The Market Discounts Everything
Technical analysts believe that all available information is already shown in the market price. The idea is based on the Efficient Markets Theory. It says the current market price is always correct. This is because it considers all known information.
Critics argue that markets are not efficient because traders can’t consider all information due to complexity and fluctuations in finance.
2. Price Moves in Trends
Technical analysis suggests that once a trend is established, the future price movement is more likely to follow the trend than to go against it.
Trends can be classified into 3 types:
- uptrends (prices going up)
- downtrends (prices going down)
- and sideways trends (prices not changing much).
While trends can be observed in many instances, they are not absolute and markets can experience reversals or shifts in direction, challenging the predictive nature of trends.
Trends are often seen, but they’re not always right and can change direction unexpectedly. This questions whether trends can predict market behaviour.
Technical analysis is based on the idea that specific patterns or price structures often repeat.
This repetitive behaviour is often explained by market psychology, as participants consistently respond to familiar market stimuli
However, critics argue that the market’s psychology is complex. It is influenced by various factors and is not solely dependent on past patterns.
Using Trend Analysis
Trend analysis is a fundamental aspect of technical analysis. It allows traders to identify potential opportunities based on market trends. A trend is the general direction in which the market is moving.
Trend analysis can be classified into 3 categories:
- uptrend
- downtrend
- sideways trend.
Trendlines and Channels
Trendlines are lines on a chart that show trends and possible reversals. Channels are made up of two parallel lines that show support and resistance to a trend.
Traders often say “The Trend Is Your Friend” to stress how important it is to follow market trends for profitable trading. Attempting to predict and trade against the trend can be risky. Because trends can persist longer than expected. It can lead to potential losses
Conclusion
Technical analysis is a valuable tool for traders and investors to understand market trends and make informed decisions. However, it is not reliable since other things can affect how markets behave, not just past prices. Trends can give us important information, but they’re not always right. To understand financial markets, we need to analyze them carefully.
