Technical Analysis is a method or tool used to predict the movement of price in the market. This analysis was founded on the idea that if a trader can observe the former patterns of the market, then he can predict the trend of the future market.
It is often used to create a short-term trading indication from different chart tools. Technical analysis improves the evaluation of the strength and weakness of the securities relative to the broader market. Traders who use this type of analysis are referred to as technical traders. Let’s review how it works, the advantages it provides and discuss some examples.
How Does Technical Analysis Work?
Using the charts to observe the price patterns and trading signals may seem overwhelming at an initial stage. So, here is how technical analysis works.
First, it attempts to capture the market sentiment and psychology by analyzing market trends and patterns for feasible trading opportunities.
Then as an investor, you could apply any of the types of technical analysis to get a profitable trade. They are “top-down” and “bottom-up” strategies. Most times, short-term traders tend to trade with a top-down strategy, and long-term traders tend to trade with a bottom-up strategy.
Here is a step-by-step approach on how to trade with technical analysis.
- As an investor, choose a strategy or trading system that works well for you
- Identify the securities you’ll want to trade
- Find the right brokerage firm that supports the securities you chose
- Track and monitor the trade you’ve entered
- If possible, use additional tools or features that’ll aid in maximizing your trading performance
Example of Technical Analysis
Let’s have an illustration of how technical analysis can be used to make trading plans.
Assume a company probably PTON has been on fire, going down on trends. And maybe, the combination of a catalyst with a $100 can bring about an amazing trading opportunity for them.
Let’s also assume that you as an investor have been waiting patiently for this breakout with PTON to happen. Finally, it does. But you decided to wait a bit more to allow them test the $100 benchmarks before you could enter a trade with them.
When that happens, you could enter a trade above the $100 mark after it has consolidated and proven itself. However, your stop loss should be the low form after-market kind which has proven supportive in previous trends.
Ideally, $110 could have been a good exit form for you with probably a 4:1 reward/risks. Speaking hypothetically, you may not have asked for anything better. But in this illustration, PTON dropped and checked your stop loss but didn’t break it.
And so, the plan worked for you. Basically, this illustration gives traders an idea of how to make trading plans with technical analysis. Being able to monitor the previous trades of PTON and knowing when to enter yours with a profitable stop loss.
Advantages of Technical Analysis
The advantages of technical analysis are that it can be effective in analyzing any form of securities. It can also be used in almost any form of trading and in any timeframe. Technical analysis can also be applied from a short-term stance to a long-term time frame. Other advantages of technical analysis are:
Generally, a trend is the direction of the market during a specific time. It could either move upwards or downwards pertaining to the bullish and bearish market respectively. The trend analysis is a strategy used in technical analysis that tries to predict the price of the future stock market.
It does this based on whatever trends may have been observed before. Technical analysis is based on the notion that whatever may have happened in the past gives traders an idea of what may happen in the future.
Trend analysis is quite useful because if a trader moves with these trends and not against them, then he’ll probably be in for a profit. There are three fundamental types of trends. They are:
- Short term trends
- Intermediate trends
- Long-term trends.
Exit and Entry Points
If you’re trading forex with exit and entry point, you’ll need lots of confidence and a good plan. The trader needs to understand what point to enter and exit the market will be best for him. These points are what determines if a trade will be successful or not.
An entry point is an exact price with which a trader opens a buy and sell position. A favorable entry point is often gotten after proper market research which is naturally part of a calculated trading strategy to minimize investment risks.
The processes involved in picking actual entry points are:
- Evaluate the market and identify a trend
- Choose your trade positions
- Use a satisfactory trading position size that is often measured in lots
- Use indicators
- Monitor your trade
- Use Limit Orders
On the other hand, an exit point is a price with which you close your position and go out of the trade. There are only two ways a trader can leave a trade. They are:
- Exit through a take-profit order
- Exit through a stop-loss order
Bear in mind that no two positions are ever alike and so you may never completely predict your outcome. Entry and exit point inclinations also vary depending on the traders’ strategy and style. And so, you should find a trading technique that’ll suit you, then pick your entry and exit catalysts that are in sync with your plan.
Learning how to exit a trade at the right time is not completely difficult. However, it requires good attention to price action, searching for a close that may indicate a trend or reversal change.
These are signals that’ll help you while trading. Although, this is often beneficial to short-term traders than long-term traders who would open a trade or position and walk away.
The stop loss is an order placed to sell assets when it has gotten to a certain price. It’s used to curb the gain or loss in a trade. When this stop-loss order is placed, the investor tells his agent to sell the securities when it gets to the pre-set price.
What Does Technical Analysis Explain?
Technical Analysis explains the trend of the market. This helps an investor or a trader know if to enter a trade or not. It does this analysis either through the economic market, financial statements, and fundamentals.
It is one of the major ways analysts and investors determine a good investment. With technical analysis, you may get to analyze the feasibility of potential and successful investments.
Beyond trading forex, technical analysis also helps analyze securities such as stocks. Stock technical analysis helps you as an investor monitor the trend of the stock market, when to buy and sell.
Typically, the financial market is any market space where trading of any securities (stocks, bonds, derivatives, or forex market) occurs. They are important to the steady operations of the capitalist economy.
The financial market plays an important role in promoting the steady operations of the economy. It does this by creating liquidity and allotting resources for investors and business owners. It makes it easier for sellers and buyers to trade their financial holding.
Technical Analysis of financial market helps traders analyze the financial market to know when to venture into a trade or not. It gives them an insight into what the future price of securities will be in the short-term. With technical analysis, the investor may know if the trade is going to become a successful one or not.
Oftentimes, the price of crypto especially bitcoin fluctuates. Bitcoin technical analysis is used by investors to foresee if the price of bitcoin in the market will rise and fall.
More importantly, technical analysis gives investors insight into the crypto marketplace. And so the more consistent you get predicting the market, the more successful trades you’re likely to have.
Controversies Around Technical Analysis
Although technical analysis is majorly used by investors, still there are controversies around it. A few investors still think otherwise of this form of trading analysis. Let’s delve further to see what these controversies could be.
Most times, investors who use technical analysis to trade usually make poor decisions which could result in low returns compared to other investors.
So, it’s observed that individuals that trade with technical analysis tend to be biased. This has sprung up controversies making technical analysis a poor means of trading.
Deception of Charts
The market trend rises and falls at every interval. Investors that do not understand this tend to see technical analysis as a deceptive method. Frankly, not every trade you venture into as an investor yields results and so when investors do not make the profits they desire, they tend to describe the analysis as not effective. This has over time been one of the few controversies that investors have.
Stock Price & Investor Psychology
With technical analysis, you’re not entirely certain if your predictions may go as planned. This uncertainty can affect the psychology of the investor. An increase in the stock price in the favour of the investor is a good deal. Otherwise, it is not.
This has affected many other investors and has increased the speculations that technical analysis may not be as effective as it seemed.
Limited Proof This Analysis Is Effective
The numbers of investors with years of trading experience that have had successful trades think that the success rates of this technique are low. This could be a result of them not analyzing a market properly before entering. Whatever the case may be, it has sprung up to become a controversy that the effectiveness of technical analysis is not particularly effective.
Technical vs Fundamental Analysis
Technical and fundamental analysis are the two ways the forex market is analyzed by investors before they enter a trade. However, they are not mutually exclusive meaning that they complement each other in analyzing the market. Let’s understand further how fundamental analysis is used.
Fundamental analysis is a method used to gauge the intrinsic value of securities by examining related financial and economic factors. In a simpler understanding, it helps investors determine a stock’s real or fair value.
If the fair market value is higher, then the stock is considered undervalued and so an investor is advised to enter a buy. Otherwise, you enter a sell.
Why Technical Analysis Shouldn’t Be Used Alone
Technical analysis should not be used alone because it’s only effective for a short-term or day trade. So if an investor decides to trade for long or probably enter a trade and leave it using the technical analysis, it may work against the trader.
Oftentimes, it’s usually advised that a trader uses both the fundamental and the technical approach to evaluate the market before entering a position.
Technical analysis is most effective for short-term basis. Whatever commodity you intend trading, either stocks, crypto or forex. These are all ways through which an investor can generate wealth for himself. Understanding how to use this analysis effectively is needful.
However, if you’re not well informed on how to use this analysis technique for trading, you may lose your money. We recommend that you employ the services of a financial advisor to help you understand the marketplace and make sustainable profits.