technical analysis

Technical Analysis is the method of forecasting future financial price movements based on an examination of past price data. Technical analysis does not try to assess a security’s intrinsic value, but instead uses charts and other tools to identify patterns that can predict what is “likely” to happen to prices over time. Technical analysis is applicable to stocks, forex, commodities, interest rates, bonds or any tradable instrument where the price is determined by the forces of demand and supply. Besides price, technical analysts also include volume and open interest data in their study of price action.

The Dow Theory, based on the collected writings of Dow Jones co-founder and editor Charles Dow, laid the foundations for what was later to become modern technical analysis. A fundamental principle of technical analysis is that all relevant information is already reflected by prices. Because market action discounts everything, analysts looks at the history of a security’s trading pattern rather than focus on external factors such as economic data or news events. Most technical analysts also agree that price trends directionally, i.e., up, down, or sideways. They argue that if price movements were totally random, it would be extremely difficult to make money using technical analysis. Another abiding principle of technical analysis is that investor behavior repeats itself over time, leading to the formation of recognizable (and predictable) price patterns on a chart, which allows a technician to select trades with a higher probability of success.

 

Merits:

  1. Technical analysis tends to focus on price, which generally precede fundamental data.
  2. Trends can easily be identified, and with the aid of modern charting software, technicians can use a wealth of different technical indicators to make more profitable and reliable trades.
  3. Technical analysis can help with timing a proper entry or exit point, which fundamental analysis tends to ignore.
  4. Technical analysis is less time consuming and inexpensive compared to fundamental analysis.

Demerits:

  1. Technical analysis is prone to personal biases.
  2. Two technicians may look at the exact same chart and arrive at two completely different scenarios. Technical analysis is subjective, and open to interpretation.
  3. Technical analysis is also severely criticized for being too late. By the time charts suggest the existence of a trend, a substantial portion of the move has already taken place.