“Technical analysis” is the term used to describe the methods traders use to identify overall market trends and potential trading setups, based on an asset’s price history. Fundamental factors are ignored when compiling this analysis but many traders tend to use fundamental rationale to justify an initial trade idea, and add technical analysis to construct a specific trading plan with pre-determined entry and exit points.
One of the benefits of Technical Analysis is that there are many different trading styles available, each catering to different personalities and investment goals. Some traders rely on underlying, long-term trends, some trade breakouts, some are contrarian and look for overbought/oversold price conditions to trigger entries. Some traders use oscillators or chart patterns while others implement the Fibonacci sequence to uncover the harmonic relationships between the smaller waves of larger price movements.
These terms might seem daunting at first. But the fact is that they sound much more complicated than they actually are, and each will be explained in greater detail in later articles. The main point to remember at this stage is that there is a vast array of options and methodologies available for each type of trading personality, so we never have to feel as though we are locked-in with one type of technical perspective.
Proponents of Technical Analysis generally tend to agree with a core set of ideas. First, is that “price is king” because all relevant information that is available to the market will immediately be factored into the asset’s price. Therefore, it is possible to make trading decisions based solely on what can be seen in the price chart. This does seem to be an irrational assertion, but when we look at chart examples, this argument will be increasingly difficult to make.
Second, is that markets “tend to trend.” Most of the time, an asset’s price will move in one direction. The possibility that the dominant trend will change does exist, but, over time, the tendency is that this will not be the case. Learning to identify the dominant trend is one of the most important skills that is required to be a successful technical trader.
Last, is the idea that the “past is prologue.” When items in the supermarket are on sale, things tend to fly off the shelves. The same is true of the stocks, commodities and FX markets. Historically low prices tend to attract buyers. High prices attract sellers. A technical trader’s job is to read a chart and accurately determine which levels previously brought in those buyers and sellers. With charts, we use the past to determine what is likely to happen again in the future and we base our trades on these assumptions.
Can we be right 100% of the time with these assumptions? Absolutely not. But all we need in order to become a successful trader is for our winning trades to out-pace our losing trades. We also need the mental fortitude to maintain a strict adherence to our original trading plan.