- Technical analysis is the analysis of the price movements in a market
- There are three assumptions of technical analysis which are market discounts everything, price move in trends and history repeats itself
- Fundamental analysis can often prove to be a better option for predicting information flow or even outcomes
What is Technical Analysis?
Technical analysis is the analysis of the price movements in a market or of an instrument over a period of time, which could range from short term to long term, to reveal investor trends.
Investor sentiments and behaviour dictate prices which are set at the meeting point of demand and supply at any given point in time.
To conduct technical analysis, one does not need to know the instrument or the market in depth but needs the data of a freely-traded instrument or market because price movements betray investor behaviour and can reveal the best time to buy or sell for investors. Analysts focus on the following indicators while doing technical analysis:
· Price trends
· Moving averages
· Chart patterns
· Momentum and volume indicators
· Resistance and support levels
The impact of supply and demand on changes in price, volume, and implied volatility is examined using technical analysis tools. It operates under the presumption that, when combined with suitable investing or trading rules, historical trading activity and price changes of security can serve as valuable predictors of the security’s future price movements.
Assumptions of Technical Analysis
Technical analysis theory is based on the following three assumptions:
The market discounts everything: Analysts believe that the impact of all the factors ranging from fundamentals to wider market psychology is already incorporated in the stock price.
Price moves in trends: According to technical analysts, prices will exhibit trends even in non-uniform market movements and this does not depend upon the time frame in consideration.
History repeats itself: According to technical analysts, History is likely to repeat itself. This is attributed to the usually predictable market psychology which affects price in a repetitive nature.
Limitations of Technical Analysis
Critics of technical analysis argue that history does not exactly repeat itself thus the assumption of the technical analysis itself is not accurate. Since, it is argued that history does not repeat itself, the critics find study of price patterns useless. Another criticism is that technical analysis works only in some cases and the reason it works is that it contains a self-fulfilling prophecy. Also, Technical analysis is limited to studying market trends and lacks the ability to deep-dive into an instrument or an industry to understand its workings.
Technical analysis is at its most relevant and insightful when the market has begun to move a certain way, rather than predicting the movement which needs fundamental background analysis.
As mentioned earlier, Technical analysis is limited to studying the market. This denies technical analysis the ability to predict possible outcomes. Fundamental analysis is better suited to predict information flow or even outcomes. Combining technical analysis with fundamental analysis leads to a sounder way of reading the markets.