What is Technical analysis?
Technical analysis uses statistical techniques of market data, the most popular being price and volume. Technical analysis use charts to identify patterns and trends as a basis for decisions. The idea is that the pattern will repeat in future and allow the investor to profit.The major difference between technical and fundamental analysis is that technical analysis do not care about the fundamental or underlying value of a stock or cryptocurrency. The only input is historic data such as historical price and volume.
There are a few types of technical analysis,
- Chart patterns
- Technical Indicators and Oscillators
- Combination of the above
These technical analysis tools rely on mainly three assumptions,
- The market has all the information
- The price follows a predictable trend or pattern
- History repeats
We consider the three technical indicators traders generally use.
The market has all the information
Fundamental analysis supporters argue that the market price does not reflect all the information and that some stocks are undervalued or overvalued when comparing the share price to the ‘value of the share’.Technical analysts believe the opposite, that the market price always reflects all future known and unknown factors.
Personally I believe that fundamental analysis is a better methodology because it requires research and understanding of the underlying asset you are buying. The technical analysis argument breaks down when news is released and the share price rockets or drop like a rock. Technical analysts argue that this is a product of supply and demand, but it wasn’t there before the news leak… as in the below example where the biotech was accused of defrauding data,
The price moves according to a predictable pattern or trend.
Technical analysts believe in short, medium and long term trends. The price may move erratically for a short period of time, but then there will be ‘corrections’. I provide an example of bitcoin and its long term trendlines as an example. There should eventually be a correction to one of these points.
History repeats
There is a belief that history tends to repeat itself. The patterns we see in the market is mainly due to investor fear and greed which are psychological, repeatable and exploitable. The idea is to analyse these patterns and movements, understand the underlying psychology and profit. As long as there is a human element to market, these patterns should continue to exist.
We take a look at some of the more well known charting patterns with examples in the next posts.
Till next time,
Tinus
** Images courtesy of tradingview.com