Technical analysis (TA), commonly referred to as chart indicators, is an analytical method that predicts future market behavior based on historical price behavior and trading volume data. Technical analysis methods are widely used in stocks and other assets in traditional financial markets, and are also an integral part of digital currency trading in the cryptocurrency market.

Unlike fundamental analysis (FA), which considers a variety of factors such as asset prices, technical analysis (TA) focuses on historical price behavior. Therefore, technical analysis can be used as a tool to examine asset price fluctuations and trading volume data, and many traders use this tool to identify market trends and favorable trading opportunities.

The earliest forms of technical analysis appeared in 17th century Amsterdam and 18th century Japan, but modern technical analysis is often traced back to the work of Charles Dow. Charles Dow, a financial journalist and founder of the Wall Street Journal, was the first to notice that individual assets and markets often exhibit cyclical trends that can be segmented and scrutinized by the public. His work later led to the development of Dow Theory, which further promoted the development of technical analysis.

In the early stages, the prototype of technical analysis used hand-made tables and manual calculations. With the development of technology and modern computers, technical analysis has become popular and has become an important tool for many investors and traders today.

How does technical analysis work?

As mentioned earlier, technical analysis is basically the study of the current and historical prices of an asset. The main premise of technical analysis is that asset prices do not fluctuate randomly, but rather show a trend over time.

At its core, technical analysis is the analysis of supply and demand market forces in relation to overall market sentiment. In other words, asset prices reflect the opposing forces of buyers and sellers, and these forces are closely tied to trader and investor sentiment (primarily fear and greed).

It is important to note that technical analysis is more reliable and effective in regular market environments with high trading volume and liquidity. Markets with high trading volume are less susceptible to price manipulation and external anomalies. These influences can send false signals and render technical analysis ineffective.

Traders use various charting tools called "indicators" to examine prices and ultimately discover profit opportunities. Technical analysis indicators help traders determine current trends and find valuable information about future trends. Because technical analysis indicators are prone to errors, some traders use multiple indicators to reduce risk.

Common technical analysis indicators

Typically, traders use a variety of technical analysis indicators and parameters to identify and discern market trends, such as charts and historical price behavior. Among the many technical analysis indicators, the simple moving average (SMA) is one of the most well-known and commonly used methods. As the name suggests, the moving average is calculated from the closing price of an asset within a set time period. The exponential moving average (EMA) is an improvement on the moving average, which pays more attention to the latest closing price.

Another commonly used indicator is the Relative Strength Index (RSI), which is an oscillator indicator. Unlike a simple moving average, which simply tracks the price difference over time, an oscillator indicator uses a mathematical formula to calculate price data and then generates parameters within a predefined range. The Relative Strength Index (RSI) ranges from 0 to 100.

Another type of oscillator indicator, the Bollinger Bands (BB) indicator, is also popular among traders. The Bollinger Bands indicator consists of two horizontal bands that flow around a moving average and is used to detect potential overbought and oversold market conditions, as well as to measure market volatility.

In addition to the basic and simple technical analysis tools, there are some indicators that combine other indicators to generate data. For example, the Stochastic RSI is calculated using a mathematical formula to calculate the regular RSI. Another common example is the MACD indicator. The main MACD line is created by subtracting two exponential moving average indicators, which is the MACD line. The first line then generates another exponential moving average line, and the second line is called the "signal line". In addition, there is the MACD histogram, which is calculated based on the difference between these two lines.

Trading Signals

Indicators help traders identify general trends and provide references to potential buy and sell price points (buy and sell signals). These signals are generated when certain events occur in the indicator chart. For example, when the Relative Strength Index (RSI) value is 70 or above, it indicates that the market is in an overbought environment. Similarly, when the Relative Strength Index (RSI) value drops to 30 or lower, it releases a signal that the market is oversold.

As mentioned before, the trading signals provided by technical analysis are not necessarily completely accurate, and technical analysis indicators can bring considerable interference factors (false signals). The cryptocurrency market is smaller and more volatile than traditional markets, so this problem is particularly worrying.

shortcoming

Despite its widespread use in a variety of markets, technical analysis is considered by many experts to be controversial and unreliable, often referred to as a “self-fulfilling prophecy” – a term used to describe events that occur simply because many people think they will happen.

Critics believe that in financial markets, if a large number of traders and investors rely on indicators such as support or resistance lines, the probability of these indicators working increases.

On the other hand, many proponents of technical analysis argue that each chartist has a particular way of analyzing charts and utilizing the various indicators available, which means that it is almost impossible for a large number of traders to use a particular strategy at the same time.

Fundamental Analysis vs Technical Analysis

The core premise of technical analysis is that market prices already reflect all fundamental factors related to a particular asset. Unlike technical analysis methods, which focus primarily on historical price data and volume (market charts), fundamental analysis (FA) uses a broader research strategy and places greater emphasis on qualitative factor analysis.

Fundamental analysis assumes that the future performance of an asset is determined by more than just historical data. Essentially, fundamental analysis uses a wide range of micro and macroeconomic conditions to measure the intrinsic value of a company, business or asset, including: company management, reputation, market competition, growth rate and industry health.

Therefore, we can say that unlike technical analysis, which is mainly used to predict price behavior and market behavior, fundamental analysis is used to determine whether an asset is overvalued in terms of background and potential. Technical analysis is mainly used by short-term traders, while fundamental analysis is usually the first choice of fund managers and long-term investors.

One of the significant advantages of technical analysis is that it is based on quantitative data. Technical analysis therefore provides a framework for objectively studying price history, eliminating some of the guesswork that comes with the qualitative approach of fundamental analysis.

However, while technical analysis uses empirical data, it is still subject to personal bias and subjectivity. For example, if a trader has a strong preference for reaching a specific conclusion about an asset, they may manipulate technical analysis tools to support their biases and reflect their preconceived notions. And many times, this happens without them realizing it. In addition, technical analysis may not work when market patterns and trends are not yet clear.

Summarize

Despite these shortcomings and the fact that there is still a debate about which method is more effective, many people believe that a combination of technical and fundamental analysis methods is a more reasonable choice. Fundamental analysis is closely related to long-term investment strategies, while technical analysis provides traders and investors with in-depth and insightful information about short-term market conditions, for example, to determine favorable market entry and exit times.