3 Basic Principles of Technical Analysis

There were some speculations that investing is more like gambling. To prove against this claim, different methods were developed in order to raise the chances of winning investments. Given the large number of publicly listed companies in the stock market, investors had a hard time determining which securities would appreciate in market value. Soon enough, noticeable patterns in the historical data of securities were discovered. This enabled the investors to predict the eventual movement of their prices. This way of analyzing the trend is technical analysis.

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What is technical analysis?

Technical analysis is an analysis method for forecasting the price movement of securities by studying their historical data. By simple definition, technical analysis attempts to determine the movement of the price in the future based on what has happened in the past. It is involves reviewing past price movements with the help of various tools such as indicators, charts, trends, and other systems that may show reoccurring patterns.

Technical analysis is applicable to stocks, commodities, futures, or any tradable asset where the price is under the influence of the forces of supply and demand. By evaluating their price swings and patterns, an investor can make an educated prediction of where the price of a security is heading off. Despite this, it is still impossible to accurately predict the market trend. It simply gives an assumption of where the price is likely to head in the future.

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Brief history

There are some evidences showing that technical analysis has started several hundreds of years ago. Although some of its aspects began to appear in the 17th and 18th century, it has been widely used during the 1920s and 1930s when Richard W. Schabacker published several books which continued the work of Charles Henry Dow and William Peter Hamilton. These 2 people formalized price-trend concepts in an effort to understand the movement of the markets. Because of this, many have considered Dow as the father of technical analysis. This is due to his views on the Dow Theory, a set of principles that served as the backbone of technical analysis. Dow’s assertions emphasized the importance of price, which when properly reviewed, can reveal aspects about a securities’ trend in the future.

3 Basic principles

  • The market discounts everything

The market price fully reflects all the information you need to know about the state a financial security is currently in. It already reflects the sum inputs of all participants that have an influence on the security, the company’s fundamentals, market sentiment, as well as changes in the supply and demand. A technical analyst will only focus on the recent patterns and changes in the price, not on what could possibly happen as the impact of speculated news releases.

  • Prices move in trends

Technical analysts believe that prices don’t often move randomly. Most of the time, prices follow a certain trend whether it is a short, medium, or long-term. By recognizing such familiar patterns in the prices of securities, one can try to forecast the possible direction it will take by simply following the same trend.

  • History tends to repeat itself

Price movements tend to repeat themselves, just like history. Technical analysis uses historical data to determine the price movement in the future. Market key players tend to react in similar fashion to certain kinds of stimuli. Thus, they usually react in the same manner when a similar situation occurs again.

Conclusion

Despite using technical analysis in predicting future price movements, there is not guarantee that it would show an accurate assumption. However, there is a possibility that it will give a very close prediction since it is based on previous facts compared to simply using your intuition.

Read about the introduction to fundamental analysis.

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