Technical analysis (TA), also known as charting, is a type of analysis that aims to predict future market behavior based on previous price movements and trading volumes. The TA method is widely applied to stocks and other assets in traditional financial markets, but it is also an indispensable component in the cryptocurrency market.

While fundamental analysis (FA), looks at many factors surrounding the price of an asset, TA only focuses on historical price action. Therefore, it is used as a tool to examine price movements and trading volumes, and many traders use this analysis to identify trends and favorable trading opportunities.

Although the first forms of technical analysis appeared in Amsterdam in the 17th century and in Japan in the 18th century, modern technical analysis is often considered to have originated from the work of Charles Dow. As a financial journalist and founder of The Wall Street Journal, Dow was one of the first to notice that individual assets and markets often move in trends, and that trends can can be segmented and examined. His work later gave birth to Dow Theory, which encouraged later developments in technical analysis.

In the early stages, the rudimentary approach of technical analysis was based on do-it-yourself spreadsheets and manual calculations, but with the advancement of technology and modern computing, TA has become popular. variable and today it is an important tool for many investors and traders.


How does technical analysis work?

As mentioned, TA is essentially a study of the current and previous price levels of an asset. The main underlying assumption of technical analysis is that fluctuations in the price of an asset are not random, and that these fluctuations often develop into identifiable trends over time.

In essence, TA is an analysis of the market forces of supply and demand, a representation of the overall sentiment of the market. In other words, the price of an asset is a reflection of opposing buying and selling forces, and these forces are closely related to the emotions of traders and investors (mainly emotions). emotions of fear and greed).

Notably, TA is considered more reliable and efficient in markets operating under normal conditions, with high trading volumes and high liquidity. High volume markets are less susceptible to price manipulation; and unusual external influences can generate false signals and render the TA useless.

To check price levels and to find favorable opportunities, traders use a variety of chart research tools, called indicators. Technical analysis indicators can help traders identify existing trends and also provide insights into possible future trends. Because TA indicators are prone to error, some traders use a combination of multiple indicators as a way to reduce risk.


Typically, traders using TA often use a variety of indicators and metrics to try and identify market trends, based on charts and historical price action. Among technical analysis indicators, the simple moving average (SMA) is one of the most used and known. As can be seen from its name, SMA is calculated based on the closing price of an asset during a certain period. Exponential moving average (EMA) is a modified version of SMA, this indicator gives more importance to the recent closing price than the old price.

Another commonly used indicator is the relative strength index (RSI), which belongs to the group of indicators known as oscillators. Unlike simple moving averages, which are only capable of tracking price changes over time, oscillators apply mathematical formulas to pricing data, thereby producing results that range from predefined range. In the case of RSI, this range is between 0 and 100.

The Bollinger Bands (BB) indicator is another oscillator that is quite popular among traders. The BB indicator consists of two bands located on either side of the moving average. It is used to detect potential overbought and oversold market conditions, as well as to measure market volatility.

In addition to the more basic and simpler TA tools, there are a number of indicators that rely on other indicators to generate data. For example, Stochastic RSI is calculated by applying a mathematical formula to the regular RSI number. Another popular example is the moving average convergence divergence (MACD) indicator. The MACD indicator is created by taking the difference of two EMAs to create the main line (MACD line). The first line is then used to create another EMA, creating the second line (called the signal line). In addition, there is also the MACD histogram, which is calculated based on the difference between these two lines.


Trading signals

While indicators are useful for identifying general trends, they can also be used to provide insights into potential entry and exit points (buy or sell signals). These signals can be generated when specific events occur in the indicator's chart. For example, when the RSI has a reading of 70 or higher, it indicates that the market is operating in overbought conditions. Likewise, when the RSI falls to 30 or lower, it is often considered a signal that the market is in oversold conditions.

As discussed above, trading signals provided by technical analysis are not always accurate and the TA indicator generates a significant amount of noise (false signals). This is especially true for cryptocurrency markets, which are smaller than traditional markets and therefore more volatile.


Critical comments

Although widely used in all types of markets, many experts consider TA to be a controversial and unreliable method, and is often referred to as a “self-fulfilling prophecy.” This term is used to describe events that only happen because a large number of people think they will happen.

Critics argue that, in the context of financial markets, if a large number of traders and investors rely on the same types of indicators, such as support or resistance lines, the This indicator will be more likely to come true.

On the other hand, many TA advocates argue that each chartist has his own way of analyzing charts and that they use a number of available indicators. That means it is unlikely that a large number of traders use the same specific strategy.


Fundamental analysis and technical analysis

The central premise of technical analysis is that market prices already reflect all the fundamental factors relevant to a particular asset. But in contrast to the TA approach which mainly focuses on price movements and trading volumes (market charts), fundamental analysis (FA) applies a broader analysis strategy and focuses on more on qualitative factors.

Fundamental analysis holds that the future performance of an asset depends on more factors than historical data. Essentially, FA is a method used to estimate the intrinsic value of a company, business or asset based on a variety of micro and macro economic conditions, such as management and reputation. of the company, market competition, growth and health of the industry.

Therefore, we can consider that unlike TA which is mainly used as a prediction tool for price fluctuations and market behavior, FA is a method to determine whether an asset will overvalued or not, according to its context and potential. While technical analysis is primarily used by short-term traders, fund managers and long-term investors tend to favor fundamental analysis.

A notable advantage of technical analysis is that it relies on quantitative data. As such, it provides a framework for the objective study of price history, eliminating the element of guesswork often associated with the more qualitative approach of fundamental analysis.

However, despite dealing with empirical data, TA is still influenced by personal bias and subjectivity. For example, a trader who is inclined to draw a certain conclusion about an asset will likely use his TA tools to support his bias and reflect his preconceived notions. Surname. And in many cases, this happens completely without them realizing it. Furthermore, technical analysis can also fail during periods where the market does not show a clear pattern or trend.


summary

In addition to criticism and the long-standing debate about which method is better, many people believe that combining both TA and FA methods is a more reasonable choice. While fundamental analysis is often associated with long-term investment strategies, technical analysis can provide insightful information regarding short-term market conditions, which can be useful for both traders and investors. traders and investors (for example, when trying to identify favorable entry and exit points).