Technical Analysis: The Basics of Reading the Market

Technical Analysis is the study of price patterns and trends in the financial markets so as to exploit those patterns. It is in effect applied mass psychology, for it studies the collective action of all market participants.

The classical method focuses on analyzing behavioral patterns and chart patterns, while the statistical method uses formulas and statistics to find mathematical patterns.

 

 

In applying technical analysis, the same skills can be applied almost universally across different charts and markets, for example a head and shoulders pattern on a stock chart can be interpreted in a similar way to one one a forex or commodity chart.

This is useful if you need an immediate opinion on a market that you know nothing about. The reason technical analysis works so well across different markets universally is because it analyses market psychology, which is the collective psychology of individual market participants.

In contrast with fundamental methods, technical analysis is much less time consuming, for example it can take as little as five minutes to analyse a chart, while doing a valuation on the same stock may take days.

This is possible because market technicians believe that market action discounts everything, so instead of trying to figure out the “true” value of a stock by valuation, the technician allows the market to do that for him, by looking at the consensus of all market participants.

In addition, technical analysis provides great timing and price projection tools, which cannot be found in the fundamentals.

Technical analysis is part art and part science, which is why both its branches complement each other in analysis.

For the classic method, there is some subjectivity involved, since different technicians can interpret the same charts in different ways. In addition, charts cannot be used to predict sudden positive or negative fundamental events, for example earnings, rights issue, M&A.

Therefore, it is also importance for technicians to keep track of company news or recent developments, since these act as price catalysts.

Fundamentals and technicals are not mutually exclusive.

One way to visualise this relationship is to think of fundamentals as the cause (economic reasons why a stock price moves), and technicals as the effect (the actual moving of the stock price).

In the short run, the cause and effect might conflict, and it is almost impossible to attribute the infinite different causes to the observed effects. However, in the long-run, they tend to converge.

Ultimately, investing is a game of probability.

Only the insiders in the company know almost everything about the company. For us, who are outsiders, although we may have gathered extensive sources of information on the company, industry, country, we may still be wrong.

Thus, it is wise to couple technicals (price consensus of all market participants) with fundamentals (specific knowledge of industry & company) to increase the probability of earning a positive return on your investments.

Technical analysis is used to find opportunities when the probabilities are in your favour, and project possible paths and key levels that prices will reach. It is using past data to make a calculated guess of the future. It is NOT a crystal ball that can forecast the future.

ALL YOU NEED TO KNOW ABOUT TRADING!

Hi, Spencer here! 😀

After making my first million at 28, and trading & teaching across 50+ countries, I have consolidated my knowledge and experience to create the most comprehensive & practical guides for profitable trading, compiled from thousands of books, websites, courses, and interviews with professionals.

As a former professional trader in private equity and proprietary funds, I have over 15 years of market experience, and have been featured on more than 20 occasions in the media.
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  1. […] Technical analysis is the studying of charts (price, volume, etc) to understand the current supply and demand, which allows you to predict the future probabilities of whether prices will head up or down, thus giving you an edge to take calculated risks. […]

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