Technical Analysis

What is Technical Analysis? - Art and science of forecasting future prices by examining past price movements. Based on analyzing demand-supply in any tradable instrument. - Analyze prices, volumes, open interest, patterns, and indicators to assess future price movements. - It can be applied to any time frame. - TA ignores fundamentals (like financial and non-financial aspects of the company) and focuses on actual price movements. - TA is not astrology for predicting future prices.

The Basis of Technical Analysis What makes Technical Analysis an effective tool for analyzing price behavior is explained by the following theories given by Charles Dow:

1. Price discounts on everything

• Each price represents a momentary consensus of value of all market participants – large commercial interests and small speculators, fundamental researchers, technicians, and gamblers- at the moment of transaction” – Dr. Alexander Elder.

• The current price fully reflects all the possible material information which could affect the price.

• The market price reflects the sum knowledge of all participants, including traders, investors, portfolio managers, buy-side analysts, sell-side analysts, market strategists, technical analysts, fundamental analysts, and many others.

• Technical analysis looks at the price and what it has done in the past and assumes it will perform similarly in the future under similar circumstances.

2. Price movements are not random

• If prices were always random, making money using technical analysis would be extremely difficult.

• Technical analysis represents a direct approach. Technical analysis is a trend following system. Most technicians acknowledge that hundreds of years of price charts have shown us one basic truth – prices move in trends.

• A technician believes it is possible to identify a trend, invest, or trade based on the trend and make money as it unfolds.

• TA can be applied to many different time frames, so it is possible to spot both short-term and long-term trends.

3. What is more important than why

• “A technical analyst knows the price of everything but the value of nothing.”

• Technical analysts are mainly concerned with two things: 1. The current price 2. The history of the price movement

• All of you will agree that the value of any asset is only what someone is willing to pay for it. Who needs to know why? By focusing just on price and nothing else.

• The price is the final result of the fight between supply and demand.

• The objective of the analysis is to forecast the direction of the future price.

• Fundamentalists are concerned with “why the price is what it is.” Technicians believe it is best to concentrate on what and never mind why. Why did the price go up? Simple, more buyers (demand) than sellers (supply)

• The principles of technical analysis are universally applicable. The principles of support, resistance, trend, trading range, and other aspects can be applied to any chart.

• TA can be used for any time horizon; for any marketable instrument like stocks, futures and commodities, fixed-income securities, forex, etc.

Technical Analysis: The basic assumptions The field of technical analysis is based on three assumptions: 1. The market discounts everything. 2. Price moves in trends. 3. History tends to repeat itself.

The market discounts everything.

Technical analysis is criticized for considering only prices and ignoring the fundamental analysis of the company, economy, etc.

TA assumes that, at any given time, a stock’s price reflects everything that has or could affect the company - including fundamental factors.

The market is driven by mass psychology and fluctuates with human emotions. Emotions may respond rapidly to extreme events but normally change gradually over time.

It is believed that the company’s fundamentals, broader economic factors, and market psychology are all priced into the stock, removing the need to consider these factors separately.

This only leaves the price movement analysis, which technical theory views as a product of the supply and demand for a particular stock in the market.

Price Move in Trends

“Trade with the trend” is the basic logic behind TA.

Once a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Analysts frame strategies based on this assumption only.

The trend is your friend. Don’t betray your friend.

History tends to repeat itself.

People have been using charts and patterns for several decades to demonstrate patterns in price movements that often repeat themselves. The repetitive nature of price movements is attributed to market psychology. Market participants tend to react to similar market stimuli over time consistently. Big Green candle = Buy, Big Red candle = Sell.