Technical analysis is a method of analysis used to analyze and (attempt to) predict the future price changes of a financial asset such as stocks, commodities, or currency pairs, only a price history is required.
To do this, various tools are used, such as charts, statistics, and indicators used together to try to get the most likely direction.
Assumptions of technical analysis
- History repeats itself – Since this method of analysis is based on the study of past movements to predict future movements, it can be said that the cornerstone of technical analysis is the assumption that history repeats itself, that is, it is cyclical, especially when it comes to asset prices.
- Market discounts everything – Another of the main assumptions is the idea that the price of a particular asset reflects all relevant factors about that asset. In other words, any fundamental data, such as a company’s financial statements or economic data are already efficiently discounted in the price and as soon as new information is presented it is reflected in the price almost immediately.
- Price moves in trends – In addition to studying past movements, many investors analyze the current price. The latest assumption is that the price moves in trends, either upward or downward in price. It is believed that after a trend is established the future price movement will be in favor of the trend and not against it.
To use the technical analysis method, traders arm themselves with a variety of tools to try to convert the indications of this tool set into the most likely direction of the price.
- Price – The price of an asset is the primary factor in technical analysis. The first thing an analyst does is analyze the price and its past movements with the perspective of trying to predict its future movements.
- Time horizons – Another relevant aspect is the time horizon, or timeframe, in which the chart is viewed. In the case of a candlestick chart for example, in a 5-minute timeframe, each candle represents 5 minutes of price movement. If viewed in a 4-hour, 1-day, or even 1-month timeframe, one candle will represent the respective time frame. The use of each timeframe is determined by the investor, who according to his preference, or personal investment style, will use the one most suitable for him. A long-term investor would not benefit from viewing a 5-minute chart, but rather a daily or weekly timeframe, for example.
- Charts – To use these tools you need something to apply them to. In the financial markets, these tools are demonstrated on charts, where the price path is plotted. The three most commonly used chart types are line, bar, and candlestick charts.
Technical analysis turns out to be the study of the price of an asset over time, something that in a concise way turns out to be simply the study of supply and demand. This method of analysis is just a tool to make a possibly better decision, hence it is useful, but it cannot be used as an absolute.
Visit the Disclaimer for more information.