Introduction to Technical Analysis

When trying to make an analysis of the value of a security, there are two general approaches most investors use: Fundamental Analysis and Technical Analysis. A “fundamental analyst” looks to understand the characteristic qualities present within a company or other tradable asset. For example, when researching a specific stock, factors such as industry competition and the previous successes of the managerial team take on a high level of importance. In contrast, a “technical analyst” is interested in none of these factors, choosing instead to focus entirely on the historical price activity as seen in charts over various time frames.

For those using this charting method, the qualities of the asset are meaningless because all of the necessary information required to make an investment decision is already contained within the price. In fact, the asset itself is also meaningless and seen as totally irrelevant. Buy and Sell signals are generated when certain criteria are met, creating commonly used chart formations. You can use the rules of technical analysis to trade IBM stock, the New Zealand Dollar, sugar futures or anything else with a legible chart showing a comprehensive price history. You can use these ideas to buy pasta in the supermarket or wine from your community liquor store.

This, for many people starting a trading career, seems to be a ridiculous or impossible assertion. How can we possibly trade an asset if we don’t know all the intricacies of the asset’s usefulness to the consumer market? How can we make predictions about a potential trade if we do not even know the identity of the underlying asset?

The answer to these questions lies in the idea that technical analysis is simply a way of understanding supply and demand. We use the information in charts in an attempt to determine which direction the market is most likely to move in the future. Certain chart formations can help us to determine the levels of probability for a given trade, based on the tendencies of the asset’s previous price activity. Here, “past is prologue.”

Technical analysis is by no means fool-proof. But an understanding of the rules that are commonly implemented by other traders will give you an additional set of tools to use when making investment decisions. It can and will be extremely helpful to know which price levels are being closely watched by a majority of market participants. Another advantage is that technical analysis can help you to identify highly specific entry and exit points, taking a great deal of guesswork and subjectivity out your trades.

Willingly overlooking this type of information can become unnecessarily costly, especially when considering the fact that technical analysis does not require complex mathematical knowledge. The basics of these techniques can be understood in a relatively short period of time. In the following articles, we will take a look at some of the most commonly used patterns and trading methods being currently being used by active market traders.