What is technical analysis?
Technical analysis is the study of past price movements to anticipate future price movements. It is the basis for the Trading the Easy Way Forex/commodity/stock trading course. Here we see learn the basics for trading the markets using technical analysis.
Technical analysis basics
Technical analysis relies on three things that generally hold true.
Price discounts everything
This is the most important thing to remember and is the key argument against using fundamentals to trade. Basically, the assumption is that at the market has at any given time already taken account of fundamental factors that could affect the price of a stock, commodity or currency.
Prices move in trends
This assumption relies on the fact that prices tend to move in trends. So once a trend has been established, the future price movement should follow this pattern.
History repeats itself
This brings in the psychological aspect of trading. Essentially, over time people in the market (investors) react in the same way to certain stimuli as in the past. Price charts can be up to 100 years old and still offer relevant guidance to future movements. In fact you can go even further back. When the dotcom bubble was expanding, many traders were drawing comparisons with past booms like the South Sea Bubble before anything messy hit the fan.
Technical analysis: is it right 100% of the time?
Quite simply, no, otherwise we'd all be millionaires. Just a quick glance at the list of different trading scams and get-rich-quick schemes shows that it if were that easy we'd all be doing it and making piles of cash. What technical analysis can do, if used carefully and diligently, is produce a high enough probability of a price moving the desired direction to successfully make money trading.
The Dow Theory: where technical analysis all began
Over 100 years old and still in use, the Dow Theory is the basis for modern technical analysis. The theory comes from a series of editorials in the Wall Street Journal written by Charles H Dow between 1900 and 1902.
Essentially what Dow did was recognise that trends changed when the pattern of peaks and troughs reversed. His theory is also based on the assumption that the markets discount everything. So, all information available is already factored into price.
Dow Theory's definition of a trend and its insistence on studying price action is considered as the main premises of modern technical analysis.
We're indebted to Dow's old publication for pointing out why technical analysis matters: "It's worth noting Dow Theory was flashing a major sell signal in the summer of 2007. The Dow industrials notched all-time highs that October before they came crashing down during the Great Panic of 2008."
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