Should I buy today? What will the prices be tomorrow, next week, or next year? Wouldn't investing be easy if we knew the answers to these seemingly simple questions? Alas, if you are reading this in the hope that technical analysis has the answers to these questions, we're afraid we have to disappoint you early--it doesn't. However, if you are reading this with the hope that technical analysis will improve your investing, I have good news--it will!
The technical analysis, is a process in which an analyst looks at the price movement forming a pattern, called a chart, and uses various highs and lows of the market to establish future price movements. The chart is a study of market actions and the people's interaction with the market. Since it is not possible to push the people into the labs, the next best way to measure the actions of the investors is to look at the chart and price movements. This entire approach is based upon the assumption that certain repetitive patterns of price and action will re occur, either before or after a significant move in price. The future prices are then predicted by using various technical tools, such as moving averages, stochastic, Relative Strength Index, Oscillators, Open Interest, and trend lines.
The main objective is to achieve the short-term price movements in the stocks, and futures. Many investors use technical analysis as a primary investment selection tool. However, it is extremely important not to have a blind faith on the results produced based on some mathematical formula. The addition of the intuition of an experienced analyst can produce effective results and may be the key to successful trading. It is very unlikely that a trader will reveal the nature of his/her techniques to researches because of the edge the techniques afford the analyst may be destroyed if other investors begin to use the same. In some cases the technical analysts use the tools, which may have no or very little significance on the chart.
The predictive skills are not easily achieved, but with very hard work, through years of experience and analysis of the market behaviour.
The term "technical analysis" is a complicated sounding name for a very basic approach to investing. Simply put, technical analysis is the study of prices, with charts being the primary tool.
The roots of modern-day technical analysis stem from the Dow theory developed around 1900 by Charles Dow. Stemming either directly or indirectly from the Dow Theory, these roots include such principles as the trending nature of prices, prices discounting all known information, confirmation and divergence, volume mirroring changes in price, and support/resistance. And of course, the widely followed Dow Jones Industrial Average is a direct offspring of the Dow theory.
Charles Dow's contribution to modern-day technical analysis cannot be understated. His focus on the basics of security price movement gave rise to a completely new method of analyzing the markets.
The price of a security represents a consensus. It is the price at which one person agrees to buy and another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to fall, he will sell it. These simple statements are the cause of a major challenge in forecasting security prices, because they refer to human expectations. As we all know firsthand, humans are neither easily quantifiable nor predictable. This fact alone will keep any mechanical trading system from working consistently.
Because humans are involved, we are sure that much of the world's investment decisions are based on irrelevant criteria. Our relationships with our family, our neighbors, our employer, the traffic, our income, and our previous success and failures, all influence our confidence, expectations, and decisions.
Money managers and home managers, students and strikers, doctors and dogcatchers, lawyers and landscapers, and the wealthy and the wanting determine security prices. This breadth of market participants guarantees an element of unpredictability and excitement.
If we were all totally logical and could separate our emotions from our investment decisions, then fundamental analysis - the determination of price based on future earnings, would work magnificently. And since we would all have the same completely logical expectations, prices would only change when quarterly reports or relevant news was released. Investors would seek "overlooked" fundamental data in an effort to find undervalued securities.
The hotly debated "efficient market theory" states that security prices represent everything that is known about the security at a given moment. This theory concludes that it is impossible to forecast prices, since prices already reflect everything that is currently known about the security.
The weakness of fundamental analysis is that you can never be sure if the facts revealed to you by the authorities are all the facts and nothing else is behind. The best analysis can be overthrown by the sudden major changes in government's policy. This sends the markets often to the opposite direction to the analyst's expectations. There are several other external factors to be taken into consideration in case of trading with strong fundamentalists. Most traders recognize that fundamental analysis provides some sort of indication of price levels, justified by the known facts. The fundamental information can also be used as background information, which may influence the individual's trading attitude. Such a trader may view the market having a character of his or her own. The market place is that prices usually discount fundamentals. By the time the news is arrived, the market prices have already discounted by the days, or may be weeks. This news could possibly be a reversal in the market trend.
Some experienced traders use technical analysis and the fundamental analysis together to make their position strong, when technical and fundamental indicators agree on the direction of currency exchange rate, futures, and movements.
Predictable trends are important for an investor to successfully apply technical analysis because that would enable the investor to take profit by selling high and buying low. The technical analysts do not possess magical powers; they only take advantage of market psychology. We can easily apply here the Newton's law of motion. The markets go up and markets go down. In fact most of time markets trade around the longer or larger movements. It is important o detect the trending market's direction, and its equally important to distinguish between trends and short term fluctuations.
There are number of tools, techniques, approaches, in fact hundreds of them in existence to forecast commodity, futures, and currency prices. Some of them are rather conventional, here I will mention a few but not the entire collection.
1-Moving Averages. 2-Trendlines 3-Stochastic 4- Oscillators 5-Volume Oscillators
6-Support / Resistance lines 7-Head & Shoulders 8-Wave theory, 9- 50 % Retracements
10-Chart formations 11-Cycle theory
To identify trends through the use of charts, the analysts must first find out the peaks and troughs in the price. A peak is the highest price in the chart and trough is the lowest value the price has taken. The peaks and troughs establish uptrends and downtrends respectively. These trends are generally founds by using trendlines. A trendline is drawn below an apparent uptrend or above an apparent uptrend. The angle of these trendlines indicates the speed of the trend, with steeper lines indicating faster appreciation and depreciation of the currency, bonds, stocks, or futures contract in question. Once a trendline has been established, the trader or investor will buy the market if the trendline is below the apparent uptrend. This position is called 'long' and when the price is below the trendline, the investor will sell, and this position is called 'short'. Selling short in currencies will make the trader money, when value of a currency is depreciating.
A 'short' seller borrows foreign currency from the bank and sells it with the hope to buy it back at a much lower price in the future. To detect a trend is equally important as spotting a trend. Peaks and troughs are also important in identifying reversals. Local peaks are called resistance levels and local troughs are called support levels. If the price of a currency or future fails to break a resistance level (a local peak level) this may be an early indication of reversal of that trend. If the price significantly penetrates the trend line, that is considered a most powerful signal of a possible reversal.
There are several types of chart patterns, which foretell the story. Following are some famous chart patterns, which can easily be recognized:
The head and shoulder pattern is recognized as three peaks, two of which being small on each size to the one in the middle with largest peak. The line between the troughs and shoulders is known as neckline. When the price penetrates the neckline of a head and shoulder, the analysts confirms a possible reversal of the previous uptrend and starts going in short positions.
There is no track record possible on chart reader in general, but a track
record is certainly feasible on the performance of an individual. Charting
very much depends upon the ability and interpretation of the technical analyst
or chartist. Sometimes the fear or greed can influence the chartist's decision
to take a position. He or she may emotionally get attached to the deals in
hand. The discipline is also extremely important factor in a chartist's life.
Technical analysis is much more complex and certainly contains many more techniques
than those mentioned herein this article. Many analysts assign themselves
with a specific type of analytical tool and if that tool generates profits,
they stick to it. Others use more exotic type of technical analysis such as
Elliott wave theory, Fibonacci numbers.
Market's history is also an important factor and must be taken into consideration
prior to entering into a buy, sell, and situation. The technical analysts
believe that their modes of analysing the markets can beat the market, and
hence allow them the make extraordinary profits. This can be achieved only
by taking huge amount of risk, and there is no other strategy to make money.
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