Technical analysis is a technique used to forecast the future direction of prices through the study of historical market data, primarily price, volume and open interest.
Technical traders use trading information (such as previous prices and trading volume) along with mathematical indicators to make their trading decisions. This information is usually displayed on a graphical chart updated in real time that is interpreted in order to determine when to buy and when to sell a specific instrument.
Dow Theory
The ideas of Charles Dow, the first editor of the Wall Street Journal, form the basis of modern technical analysis. They are based upon three main premises:
- The price is a comprehensive reflection of all market forces. At any given time, all market information and forces are reflected in the prices.
- Prices move in trends that can be identified and turned into profit opportunities.
- Price movements are historically repetitive.
Advantages of Technical Analysis
It requires much less data than fundamental analysis. From price and volume, a technical trader can obtain all the information he needed.
As it is focused on identifying trend reversal, the question of timing to enter a trade is easier to address with technical analysis.
Drawbacks of Technical Analysis
Technical analysis can become a self-fulfilling prophecy. When many investors, using similar tools and following the same concepts, shift together the supply and demand, this can lead to the prices moving in the predicted direction.
Technical and/or Fundamental Analysis
Technical Analysis is one of the most significant tools available for forecasting financial market behavior. It has been proven to be an effective tool for investors and is constantly becoming more accepted by market participants. When used in conjunction with fundamental analysis, technical analysis can offer a more complete valuation, which can make the difference in executing profitable trades.
