What is Technical Analysis? – Examples, Advantages and Disadvantages
What is Technical Analysis?
Technical analysis is a system that allows you to examine and predict price movements in financial markets based on historical data and market figures. It is based on the indication that if a trader can identify previous patterns, he will be able to predict future price movements accurately.
Identifying patterns on a graph is the only thing using to predict future movements. Along with elemental analysis, it is one of the two leading schools of market analysis. While fundamental research focuses on the absolute value of the asset, thus taking into account external factors and the intrinsic value, technical analysis is based exclusively on the price charts of an investment.
Examples of Technical Analysis Tools
Technical analysts have a wide variety of tools to spot trends and designs on charts. These comprise moving averages, support and resistance levels, or Bollinger bands. All the devices share the same goal: that investors who use technical analysis better understand the movements of the charts and can identify trends more quickly.
Technical Analysis Tools
The importance of technical analysis lies in using numerous tools and signals that make trading much more automated. Next, we leave you with the most outstanding.
Support and Resistance
The function of these tools lies in showing the points where the price of a security is in its market range, between a usual maximum (resistance) and a usual minimum (support). When any of these marks are broken, we can expect the price to be trending, and therefore it may be time to act.
Take Profit A little in line with support and resistance are the stop loss and the take profit, which are tools that we establish to mark the limit of our operations. The stop loss represents the maximum loss that we are willing to bear. The take profit, meanwhile, represents our profit target. Thus, if we conduct a technical analysis on Repsol stock and see that the price has broken through resistance, perhaps it is time to open a position.
Retracements are percentages. It is possible that, during the session (with the market open), the instrument you are studying or in which you are invested will go back to previous days’ prices. It can be up or down. The most commonly used setback is 50%. The levels corresponding to one third, 38% and 2/3 are also used.
The easiest way to start an analysis is to know and apply trend lines. The first thing to do is draw a straight line joining two points on the graph. To remove an uptrend line, join two consecutive lows, and for a downtrend line, join two successive highs. You will notice that the price usually retraces to a trendline before continuing it. When the price breaks a trend line, the trend has ended. Note that a trend line validates when the price touches it three times. The longer a trend line is, the more times it has test, and the more critical it is. For example, stock technical analysis implies that if we follow the trend lines.
When looking for buy and sell signals, it is necessary to check the moving averages. These averages indicate whether an existing trend is still valid. Be careful: these do not predict changes in the direction. Traders often use two moving averages. Movements above and below the 20 and 40-day moving averages are trendy. The five and 20-day averages are highly appreciated by those who trade on very short timeframes.
Oscillators are often used to identify overbought or oversold conditions in the markets. These allow you to know if the market has gone up or down excessively and wait for an imminent change. Traders most use the Relative Strength Index RSI and the stochastic oscillators. These oscillators have a scale that goes from 0 to 100. Regarding the RSI: if its value is above 70, there is overbought. If the RSI is below 30, it means that it is oversold. Regarding the stochastic, 80 indicates overbought and 20 oversold.
Advantages and Disadvantages of Technical Analysis
Advantages of Technical Analysis
Identifying the signals of the price trend in the market is a critical factor in any trading strategy. All investors need to develop a methodology to locate entry and exit points in the market. One of the most popular methods is to use technical analysis tools.
Technical analysis tools are so commonplace that some believe they create self-fulfilling trading rules: The more investors use the same indicators to find support and resistance levels, the more buyers and sellers will interested in trading. The exact price points and the patterns will inevitably repeat themselves.
Disadvantages of Technical Analysis
There is no guarantee that any type of analysis is 100% correct, neither technical nor fundamental. Although historical price patterns can give us an idea of the possible price path of an asset, this is not a guarantee that it will happen. There will always be a part of market behaviour that is erratic.
Investors should use various indicators and technical analysis tools to gain the highest possible level of safety and have a risk management strategy to protect themselves in downtimes.
Importance of Technical Analysis when Investing
Technical analysis allows you to analyze any market, station, index, currency, or rate, regardless of the language in which they express.
When you get into the world of the Stock Market, you can use technical analysis to have a visual and intuitive perception of what is happening in the market and thus make a decision when investing.
This analysis makes intensive use of charts, mathematical formulas and indicators and designers to study very liquid markets in which no operator has dominant power over the others. Another of its features is that it bases on psychology. Because the Stock Market is where feelings have an important place and where the price of shares or assets constantly fluctuates, he can make hasty or wise decisions when an investor finds a pattern in the historical cost. According to the case.
Interestingly, this analysis used only in the Stock Market, unlike fundamental analysis, which applies in any field of investment or the world of entrepreneurs. Technical analysis offers different studies used in a complementary way, such as trend lines, support and resistance, price patterns, moving averages, price swings and MACD, and Japanese candles.
A hedge fund manager, Michael Burry, has said that he uses technical analysis to find entry or exit points and find out both new lows and new highs.
The Mexican Stock Exchange (BMV) has various indices that help reflect the behaviour of the stock market. We invite you to read: “ Relationship between the PC and the stock market ” to learn about them.