What is technical analysis?

Technical analysis (TA) is a study of the history of prices and trading volumes in order to identify patterns on the basis of which price dynamics are predicted. Technical analysis is applicable to any asset with a history of price changes in the past, including cryptocurrencies , fiat money, commodities and stocks.

Who developed the technical analysis when?

Primitive forms of technical analysis appeared in Amsterdam in the 17th century and in Japan in the 18th century. Modern TA has arisen thanks to the work of American journalist Charles Dow, the founder of The Wall Street Journal. Dow was one of the first to note that assets and markets often develop within the framework of trends that can be fragmented and analyzed. Based on his observations, he created a concept known as the Dow theory .

Key points of the Dow theory

• Pricing is driven by everything on the market; all present, past and future factors (demand, regulatory changes, expectations of market participants, etc.) are already taken into account in the current price of an asset and trading volume. Studying the dynamics of price / volume is enough to predict the likely development of market events.
• The main thing is “what,” not “why.” The technical analyst’s focus is on the price of the asset, not the various variables that produce the price movement. Price is a reflection of the opposing forces of supply and demand, which are closely related to the emotions of fear and greed of market participants.
• Price movements are not unsystematic, but subject to trends. The totality of changes in the balance of supply and demand over a certain period of time forms trends (short-, medium- and long-term). If demand exceeds supply, an uptrend occurs, if supply exceeds demand - downward. When supply and demand balance each other, a side price trend (flat) occurs.
• History tends to repeat itself. Market psychology can be predicted, as traders respond stereotypically to similar factors.

How is technical analysis different from fundamental?

In contrast to the approach adopted by the TA, where price histories and trading volumes are of paramount importance, fundamental analysis (FA) is designed to evaluate the intrinsic value of an asset and takes into account not only quantitative, but also qualitative factors, including:

• financial and production indicators;
• company management and reputation;
• market competition;
• general state of the industry, etc.

Based on these data, future asset indicators are projected.

FA is more efficient and reliable in markets operating under normal circumstances, with high trading volume and high liquidity. Such markets are less prone to price manipulation and external influences that generate false signals and make TA of little use.

Technical analysis is used primarily as a tool for predicting price movements and market behavior, fundamental analysis - as a method of assessing the value of an asset in accordance with its potential and context.

TA is popular among short-term traders, FA - among fund managers and long-term investors.

How does technical analysis work?

In technical analysis, patterns are considered and analyzed - typical patterns formed on price charts (“Double bottom”, “Triangle”, “Flag”, etc.), as well as levels, often based on previous highs or lows of prices. As the price approaches the previous peak values, market participants expect similar reversals and seek to issue appropriate trading orders, which in turn forms resistance and support levels.

For the technical analysis of prices, levels and patterns, charts are used that display changes in prices over a certain period of time. The most popular among traders are candlestick charts, linear, as well as bar charts (bars).

Japanese candles can be used both as independent TA models and in combination with additional tools - geometric shapes, indicators , oscillators , etc.

Patterns are usually identified on the charts by traders themselves, without the use of auxiliary mathematical tools.

Additional TA Tools

• The horizontal line is a straight line that indicates the price levels on the chart.
• The trend line is a sloping straight line to identify trends.
• Settlement lines formed on the basis of mathematical processing of user-specified key values ​​( Fibonacci levels , Gann lines).

Technical indicators

Technical indicators - additional charts formed on the basis of recalculation of values ​​contained in the base price chart. They have at least one variable parameter, from the value of which the displayed results can significantly change. The following indicators and metrics are used within TA:

Simple Moving Average (SMA), calculated on the basis of the closing price at the due date.

Exponential Moving Average (EMA) - A modified version of the SMA, which takes into account the latest rather than old closing prices.

Relative Strength Index (RSI) is a type of indicator known as oscillator. Unlike simple moving averages that simply track price changes over time, oscillators apply mathematical formulas to price data to get readings falling into predefined ranges. In RSI, this range is from 0 to 100.

Bollinger Bands (BB) is an indicator consisting of two side bands flowing around the moving average. It is used to determine potential overbought and oversold conditions of the market, as well as to measure market volatility.

Along with basic and simple tools, TA uses tools based on other indicators:

The stochastic RSI is calculated by applying a mathematical formula to the regular RSI.

A moving average divergence indicator (MACD) is generated by subtracting two exponential moving averages (EMA) to create a main line (MACD). Then, using the first line, another EMA is generated and a second, signal, line appears. There is also a histogram (graphical representation of statistical data) of the MACD, calculated on the basis of the differences between the two lines.

Trading Signals

Indicators, along with helping to identify common trends, provide data on potential entry and exit points (buy and sell signals). Signals are generated when certain events occur on the indicator chart. For example, a value of the relative strength index (RSI) of 70 or more may indicate a state of overbought market, and a fall in RSI to 30 or less usually indicates an oversold market.

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Cons TA

TA trading signals provided are not always accurate. Indicators create a significant amount of “noise” (false signals), which is especially true in cryptocurrency markets, which are much smaller and more volatile than traditional financial markets.

Critics call TA “a self-fulfilling prophecy,” that is, predicting events that occur only because a large number of people allow the likelihood of a particular scenario. As many traders and investors use the same indicators, such as support and resistance levels, these schemes become working. On the other hand, each trader analyzes the market movement charts in his own way, using the many available indicators. This means that a large group of tech analysts cannot use the same strategy.

Although TA deals with empirical evidence, it is not free from the influence of bias and subjectivity. A trader, predisposed to certain conclusions about the asset, may well manipulate the tools to reinforce his point of view. Quite often this is done unconsciously. Also, technical analysis crashes during periods when the market does not provide distinct patterns or trends.

Many consider the combination of FA and TA as the most rational approach: the first method works well for long-term investment strategies, the second - for short-term transactions.