Does Technical Analysis Work: Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
Technical traders believe that current or past price action in the market is the most reliable indicator of future price action. Technical analysis can be applied to any security with historical trading data.
This includes futures, commodities, currencies, and other such securities. It is a common myth that technical analysis is only appropriate for short-term and computer-driven trading.
Technical analysis existed and was practiced before computers were common, and some of the pioneers in the technical analysis were long-term investors and traders, not day traders.
Technical analysis is used by traders on all time frames, from one-minute charts to weekly and monthly charts. Let’s dive into the topic and find out
Technical Analysis Can Be Split Into 3 Distinct Categories
(1) Candlesticks and Chart patterns
(2) Support/resistance zones
(3) Technical indicators
Candlestick charting is the most commonly used method of showing price movement on a chart. A candlestick is formed from the price action during a single time period for any time frame.
Each candlestick on an hourly chart shows the price action for one hour, while each candlestick on a 4-hour chart shows the price action during each 4-hour time period.
Candlesticks are formed as follows: The highest point of a candlestick shows the highest price security traded during that time period, and the lowest point of the candlestick indicates the lowest price during that time.
The “body” of a candlestick indicates the opening and closing prices for the time period. If a green candlestick body is formed, this indicates that the closing price was higher than the opening price conversely, if a red candlestick body is formed, then the opening price was higher than the closing price.
A chart pattern is a graphical presentation of price movement using a series of trend lines or curves. Chart patterns can be described as fluctuations in the price of a financial asset that is caused by a number of factors, including human behaviour.
Chart patterns are the foundation of technical analysis. In technical analysis, chart patterns are used to find trends in the movement of an asset’s price.
A trader armed with the knowledge required to recognize patterns, along with the skill to apply them to their decision-making process can increase their odds of anticipating where the price will move next.
There are two basic types of patterns: continuation and reversal.
Continuation patterns identify opportunities for traders to continue with the trend. The most common continuation patterns include Triangle patterns and Flag patterns.
The opposite of a continuation pattern is a reversal pattern. These are used to trade the reversal of a trend. Reversal patterns are found where trends have ended. Common reversal patterns are Double Tops and Double Bottoms, Head-and-Shoulders and Inverse Head and Shoulders.
Support and resistance are two foundational concepts in technical analysis. Understanding what these terms mean and their practical application is essential to correctly reading price charts.
In a downtrend, prices fall because there is an excess of supply over demand. The lower prices go, the more attractive prices become to those waiting on the sidelines to buy the shares.
At some level, demand that would have been slowly increasing will rise to the level where it matches supply. At this point, prices will stop falling. This is support.
Prices move up because there is more demand than supply. As prices move higher, there will come a point when the selling will overwhelm the desire to buy.
This happens for a variety of reasons. It could be that traders have determined that prices are too high or have met their target. It could be the reluctance of buyers to initiate new positions at such rich valuations.
It could be for any other number of reasons. But a technician will clearly see on a price chart a level at which supply begins to overwhelm demand. This is resistance.
Technical indicators are mathematical calculations based on the price, volume, or open interest of a security or contract used by traders who follow technical analysis.
Technical analysts or chartists look for technical indicators in historical asset price data to judge entry and exit points for trades. Some technical indicators generate signals stand-alone, while others supplement each other.
As elements of technical analysis, they are used to evaluate a security’s strength or weakness by focusing on trading signals, patterns or price movements, and other analytical charting tools.
There are several technical indicators that fall broadly into two main categories: overlays and oscillators.
- Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart. Examples include moving averages and Bollinger Bands.
- Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD, or RSI
Technical analysis provides a large basket of tools and concepts for trading. There are successful traders who don’t use it, and there are successful traders who do.
Some believe technical analysis is the best way to trade, while others claim it is misguided and lacks a theoretical basis. Ultimately, it is up to each trader to explore technical analysis and determine if it is right for them.
It doesn’t guarantee instant profits or 100% accuracy, but for those who diligently practice the concepts, it does provide a realistic possibility of trading success. That’s all for the article Does Technical Analysis Work? We hope you enjoyed reading it. Happy Investing!
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