Technical analysis (TA) is a type of analysis that allows you to predict market behavior based on previous price movements and trading volumes. It is widely applied to stocks and other assets in traditional financial markets, and is also an integral component of digital currency trading.

Unlike fundamental analysis (FA), which takes into account many factors affecting the price of an asset, technical analysis focuses only on historical price movement. It allows traders to study price fluctuations and trading volumes to identify trends and favorable trading opportunities.

The first forms of technical analysis appeared in the 17th century in Amsterdam and in the 18th century in Japan, but modern analysis can be traced back to the work of financial journalist and founder of The Wall Street Journal, Charles Dow. Dow was one of the first to notice that individual assets and markets often move in accordance with certain trends. The result of his work was the Dow Theory, which contributed to the further development of technical analysis.

In its early stages, technical analysis relied on handwritten tables and manual calculations, and as technology advanced, it became widespread. Now it is an important tool for many investors and traders.


How does technical analysis work?

Technical analysis consists of studying the current and previous prices of an asset. It is based on the assumption that price fluctuations are not random and over time turn into identifiable trends.

Technical analysis is the study of the market forces of supply and demand that reflect the overall sentiment of the market. In other words, the price of an asset reflects the opposing forces of selling and buying, which are closely related to the emotions of traders and investors (namely fear and greed).

Technical analysis is considered most effective when examining markets with high trading volume and liquidity that operate under normal conditions. Markets with large trading volumes are less susceptible to price manipulation and abnormal external influences that distort TA results.

To study prices and identify opportunities, traders use various charting tools known as indicators. Technical analysis indicators help traders identify existing and potential trends. Because technical analysis results are not always reliable, some traders use multiple indicators to reduce risk.


Technical analysis indicators

Technical analysis traders study many different indicators and metrics. This allows you to determine market trends based on charts and historical price movements. Simple moving averages (SMAs) are one of the most commonly used examples. They are calculated based on the closing prices of an asset over a specified period of time. An exponential moving average (EMA) is a modified version of a simple moving average that places more emphasis on recent closing prices.

Another popular indicator is the relative strength index (RSI), which is part of a class of indicators known as oscillators. Unlike simple moving averages, which track price changes over time, oscillators use mathematical formulas to determine price data that occurs over a specific period. When using the relative strength index, this range ranges from 0 to 100.

Bollinger Bands (BB) are another popular type of oscillator that represents upper and lower boundaries around a moving average. Bollinger Bands are used to determine whether a market is potentially overbought or oversold and to measure volatility.

In addition to simple technical analysis tools, there are indicators that generate data based on other indicators. For example, stochastic RSI is calculated by applying a mathematical formula to regular RSI. Another popular example is the moving average convergence divergence (MACD) indicator. The MACD is determined by subtracting the two EMA indicators to create the main MACD line. The first line is used to plot another EMA, resulting in a signal line. The MACD histogram is then calculated based on the differences between these lines.


Trading signals

Indicators are useful not only for identifying general trends, but also for obtaining information about potential entry and exit points (buying and selling). Buy and sell signals are recorded when certain events are observed on the indicator chart. For example, when the RSI value exceeds 70, the market can be said to be overbought, while an RSI drop to 30 usually indicates that the market is oversold.

Technical analysis trading signals are not always accurate and in some cases may be false. This is especially true for cryptocurrency markets, which are smaller than traditional ones and therefore more volatile.


Criticism

Although technical analysis is widely used in various markets, many experts call it an unreliable tool and a “self-fulfilling prophecy.” This term is used to describe events that occur only because a large number of people believe in a similar outcome.

Critics believe that if a large number of traders and investors rely on the same types of indicators, such as support or resistance lines, the chances of these indicators working increases.

On the other hand, many proponents of technical analysis argue that every trader has a special way of analyzing charts and indicators. According to this opinion, with all the diversity of data, a large number of traders cannot develop a single strategy.


Fundamental analysis or technical analysis

Technical analysis relies on the assumption that market prices reflect all the fundamental factors associated with a particular asset. But unlike technical analysis, which focuses on historical data and volume, fundamental analysis (FA) uses a broader research strategy that pays more attention to qualitative factors.

Proponents of fundamental analysis believe that the future movement of an asset's price depends not only on historical data. Fundamental analysis is a method used to estimate the intrinsic value of a company, business or asset based on a wide range of micro and macroeconomic conditions, such as the company's management and reputation, market competition, growth rate and industry conditions.

This means that while technical analysis primarily serves as a tool for predicting price movements and market behavior, fundamental analysis reveals whether an asset is overvalued depending on its context and potential. Therefore, technical analysis is mainly used by short-term traders, while fundamental analysis is used by fund managers and long-term investors.

A significant advantage of technical analysis is its reliance on quantitative data. Thanks to it, it provides the basis for an objective study of price history, while fundamental analysis only allows you to make assumptions based on qualitative data.

However, despite working with empirical data, the results of technical analysis can be influenced by personal biases and subjectivity. For example, a trader who intends to withdraw an asset may unknowingly manipulate the results of the analysis so that they correspond to his expectations and desires. Additionally, technical analysis may not be effective during periods when markets are not trending clearly.


Summary

Considering the arguments of critics and supporters of technical and fundamental analysis, many recommend using a combination of these methods. Thus, FA will be useful for long-term investment strategies, and TA will provide relevant information about short-term market conditions that can be used by both traders and investors (for example, to determine optimal entry and exit points).