Utilising emotion-free analysis and combining it with fundamental analysis
Technical analysis is the approach to trade the market without emotions, based on the markets past performance. It aims to understand how the markets will perform in the future, purely based on what it has previously done. It looks only at measurable things – previous price levels, volume, swings and volatility among others. The fact that humans stand behind all of this is put aside in favour of a more scientific and impartial approach. Not to mention that most of trading nowadays is done by programmed algorithms.
This type of analysis is based on several assumptions about the market. The main one is that what occurred in the past will inevitably repeat itself in the future. This can mean that certain price levels will be reached again, or that a similar pattern or trend will be replicated in some form or another. In any case, it is an overarching assumption that repetitiveness is commonly observed in the markets, as their governing principles don’t change, they just operate in different circumstances.
Technical analysts see the market as an efficient mechanism, hence its predictability. They assume that the variables that comprise the buying and selling are factored in the current price, literally at all times. They then take this price as proof of a movement that is unfolding.
So how is technical analysis performed? As mentioned the foundation here is something that can be measured, so over the years different indicators have been developed to measure and predict different aspects of price movements. There is a vast array of these indicators. The most popular among them are Relative Strength Index, Moving Averages, the variations of the Fibonacci numbers and the multitude of oscillators. But there are tens, even hundreds more. Some focus on how the price has behaved in terms of volatility, others take into account the underlying instrument’s condition in terms of buying or selling (making it overbought or oversold) or something else.
The pros of these indicators are that there are numbers behind them and if read properly they can give defined entry and exit points for trades. So the trader doesn’t have to read news, opinions and projections – they just have to see if the indicator(s) they’ve selected reflect the market well. With this trends are more easily recognized on line or candlestick charts, as well as support and resistance levels and zones.
Detractors of technical analysis point to some weaknesses in the way it’s used. Their main argument is that the world is actually changing and evolving, and foundations of economics, business, our way of life and how we think shift. Most people and businesses exist within boundaries, but once in a while there are those who manage to disrupt and change things so much, that previous limitations are thrown aside for progress to erupt.
Factors such as competition, improvement and potential aren’t always quantifiable and this is where human judgement is required to see the full picture, beyond something that relies on massive amounts of data. This brings us to how fundamental and technical analysis can be combined for a more complete view on what is going on with a certain currency, country or company. As changes to them happen either slowly or really rapidly, a combination of fundamental and technical analysis has its merits.
Fundamental analysis is often used for longer term trades, or for identifying a major trend that can be taken advantage of multiple times at retracements. Technical can also help with this, but tends to be more frequently utilised for short term trades. With this in mind many traders follow everyday news and updates on their preferred instruments and double check with technical levels for opportune moments to enter and exit, adding more context to their decisions. In this way they spread the factors that influence them between their own judgement and quantifiable values.
Fans of the efficient market theory would say that fundamental analysis is altogether unnecessary and just bogs you down. Others might just check with technical indicators to confirm what their fundamental research has shown. Whatever you choose, the market will remain an unstable mix of psychology, supply and demand. After all, even algorithms are created by humans with emotions.