Technical analysis (chart analysis) examines the price and volume movements of financial markets. The goal of technical analysis is to identify trends as early as possible and derive potential trading signals from them. Simple trend lines and various technical indicators are used for this purpose. Most indicators are derived from price data, but can also be based on trading volume, market breadth data, or market sentiment data.
Successful traders use trading systems that generate trading signals according to specific rules. Traders thus react to trading signals in a targeted manner, but do not attempt to predict prices.
Basic assumptions of technical analysis
The origins of numerous principles of technical analysis can be found in Dow Theory. The three most important basic assumptions on which the technical approach is based are:
- Market movement discounts everything
- Prices move in trends
- History repeats itself
Market movement discounts everything
The chart technician assumes that everything that can potentially influence prices – fundamental, political, psychological, or other factors – is reflected in the current market price. The logical conclusion is that only the analysis of the market price is necessary.
Prices move in trends
This is probably the most important premise upon which numerous other principles are built. This principle is based on Newton's Law of Motion, which states: A trend in motion is more likely to continue than to reverse. Consequently, it is important to identify trends in the early stages of their development and to trade accordingly.
History repeats itself
Technical analysis also incorporates an understanding of human psychology. Market patterns or periods of exuberance are often based on mass psychological phenomena that can be observed regularly. Put another way: The key to understanding the future lies in studying the past, or the future is simply a repetition of the past.
Author
DI Nikolaos Nicoltsios
Trader and developer of trading systems