Technical analysis

Technical analysis

Technical analysis is research of market dynamics done mainly with the help of charts, and for the purpose of forecasting future price movement.

Technical analysis comprises several approaches to the study of price movement which are interconnected within the framework of one harmonious theory.

This type of analysis studies the price movement in the market by analyzing three market factors: price, volume, and in the case of futures contracts, the number of open positions.

Of these three factors, the primary one for technical analysis is that of price. Changes in other factors are studied, mainly in order to confirm the correctness of the identified price trend. This technical theory, just like any theory, has its core postulates.

Technical analysts base their research on three axioms:

􀂉 Market movement considers everything

This is the most important postulate of technical analysis. It is crucial to understand it in order to grasp the procedures of analysis. Put simply, any factor that influences the price of securities, whether economic, political, or psychological, has already been taken into account and reflected in the price chart.

In other words, every price change is accompanied by a change in external factors. The main inference of this premise is the necessity to follow closely the price movements and analyze them. By means of analyzing price charts and multiple other indicators, a technical analyst reaches the point that the market, itself, shows him/her the trend it will most likely follow.

This premise is in conflict with fundamental analysis where the attention is primarily paid to the study of factors, and later on, after the analysis of the factors, conclusions as to the market trends are made.

Thus, if the demand is higher than the supply, a fundamental analyst will come to the conclusion that the price will increase. A technical analyst, however, makes his/her conclusions in the opposite sequence: since the price has increased, it means the demand is higher than the supply.

􀂉 Prices move with the trend

This assumption is the basis for all methods of technical analysis, as a market that moves in accordance with trends can be analyzed, unlike a chaotic market.

The postulate that the price movement is a result of a trend has two effects: The first implies that the current trend will most likely continue and will not reverse itself, thus, excluding disorderly chaotic movement of the market. The second implies that the current trend will go on until the opposite trend sets in.

􀂉 History repeats itself

Technical analysis and study of market dynamics are closely related to the study of human psychology. Thus, the graphical price models identified and classified within the last hundred years depict core characteristics of the psychological state of the market.

Primarily, they show the moods currently prevailing in the market, whether bullish or bearish. Since these models worked in the past, we have reason to suppose that they will work in the future, for they are based on human psychology which remains almost unchanged over the years.

We can reword the last postulate — history repeats itself — in a slightly different way: the key to understanding the future lies in the study of the past.