Everything you should know about Market Technical analysis

What is technical analysis?

Technical analysis is a complex of market analysis methods and provision of market information for making trading decisions.

Joseph de la Vega was the first one who described ideas which are similar to those that are used in modern technical analysis. He lived in Amsterdam from 1650 until 1692 and wrote the ‘Confusion of Confusions’ book, which was a study about trades on the Amsterdam Stock Exchange (see the picture above).

There is also an opinion that technical analysis originated in Asia. Homma Munehisa started to develop it at the beginning of the 18th century in the form of candlestick chart analysis.

However, Charles Dow (1851-1902), a journalist, is number one in the development of technical analysis. He founded The Wall Street Journal and published 255 editorials in it, where he thoroughly analysed the American stock market data. According to his opinion, these data contain regularities and cycles. This concept is known as ‘Dow theory’.

Richard Schabacker developed the Charles Dow study further and published the ‘Stock Market Theory and Practice’ book in the 1920s and 1930s.

Robert D. Edwards and John Magee published the ‘Technical Analysis of Stock Trends’ book in 1948. It is believed to be one of the benchmark studies in TA. That work described patterns which are used even now.

Ralph Nelson Elliott, William Delbert Gann and Richard Wyckoff, who developed market technical analysis methods at the beginning of the 20th century, are among pioneers of the analysis methods.

Technical analysis passed through the stage of rapid development in the second half of the 20th century due to emergence and widespread use of computers.

Generally speaking, technical analysis of financial markets lies in the study of markets on the basis of historical price movements.

TA works on the basis of the theory that markets have a tendency to move in sequential and repetitive patterns. That is why these patterns can be identified, and their repetition can be used, if you analyse the previous price action (under similar conditions).

Let’s highlight 3 benchmark technical analysis principles.

Principle 1. Markets take into account everything. This assumption tells us that all known and unknown information has been already reflected in the most recent price. For example, an insider can buy the company stock in big volumes in expectation of good quarterly reports. While he is doing it ‘under the table’, the price reacts to his actions, showing a technical analyst through the chart that the idea to buy is a good one.

The ‘markets take into account everything’ principle accords with the market efficiency theory. However, this theory doesn’t help traders to make money, since markets do not give them chances. In our view, it is not quite so, because the price also takes into account erroneous opinions, for example, trades that were executed on the basis of emotions, rumors or lagging indicators.

Principle 2. Price moves along a trend. All main market movements are the result of a trend. The trend concept is the foundation of technical analysis. Wyckoff called a trend the line of the smallest resistance for the price movement. The Dow theory specifies three trend types: primary (or long-term), secondary (or intermediate-term) and small (or short-term).

Principle 3. History tends to repeat itself. This happens because market participants react to the price movement pretty much similarly due to their psychology. For example, market participants become greedy in the markets with an uptrend and want to buy, regardless of how high the prices are. In the same way, market participants start to panic when they see a downtrend and want to sell, despite the fact that the prices are extremely low.

Here, we should also mention behavioural finance as an individual discipline in the economy and Paul Azzopardi, who combined TA with behavioural finance and introduced the ‘behavioural technical analysis’ term.

Technical analysis of the market is very subjective, and this is a big disadvantage. However, alongside with disadvantages, TA has obvious advantages:

• It is clear and easy to understand. However, note that this doesn’t mean that trading can be easy in making money. Any person will need a lot of time, patience and certain training, in order to understand the market.
• One and the same strategy can be used in several markets. Regardless of whether you analyze futures, forex, primary commodities or stocks, you can apply one and the same strategy under condition that the historical data and liquidity are available in the studied market.
• You can use technical analysis in any time-frame, so that it corresponds with your trading style preferences better. Scalpers, intraday traders, swing traders and long-term investors can get big benefits from technical analysis of the markets.
• Technical analysis is sequential. It can be studied through historical data testing, in order to train yourself and improve your results.