Technical Analysis for Beginners Explained

technical analysis

Who remembers when the fundamental analysis was considered the only real or proper way to make trading decisions? Back in 1970-1980, technical analysis was used by only a handful of traders, who were considered by the rest of the market community to be, at the very least, crazy. As difficult as it is to believe now, it wasn't very long ago when Wall Street and most of the major funds and financial institutions thought that technical analysis was some form of mystical hocus-pocus. Now, of course, just the opposite is true. Almost all experienced traders use some form of technical analysis to help them formulate their trading strategies. Except for some small, isolated pockets in the academic community, the "purely" fundamental analyst is virtually extinct. What caused this dramatic shift in perspective? 

Why Technical Analysis

We're sure it's no surprise to anyone that the answer to this question is very simple: Money! The problem with making trading decisions from a strictly fundamental perspective is the inherent difficulty of making money consistently using this approach. For those of you who may not be familiar with fundamental analysis, let me explain. Fundamental analysis attempts to take into consideration all the variables that could affect the relative balance or imbalance between the supply of and the possible demand for any particular stock, commodity, or financial instrument.

Using primarily mathematical models that weigh the significance of a variety of factors (interest rates, balance sheets, weather patterns, and numerous others), the analyst projects what the price should be at some point in the future. The problem with these models is that they rarely, if ever, factor in other traders as variables. People, expressing their beliefs and expectations about the future, make prices move—not models. The fact that a model makes a logical and reasonable projection based on all the relevant variables is not of much value if the traders who are responsible for most of the trading volume are not aware of the model or don't believe in it. As a matter of fact, many traders, especially those on the floors of the futures exchanges who have the ability to move prices very dramatically in one direction or the other, usually don't have the slightest concept of the fundamental supply and demand factors that are supposed to affect prices.

Furthermore, at any given moment, much of their trading activity is prompted by a response to emotional factors that are completely outside the parameters of the fundamental model. In other words, the people who trade (and consequently move prices) don't always act in a rational manner. 

Ultimately, the fundamental analyst could find that a prediction about where prices should be at some point in the future is correct. But in the meantime, price movement could be so volatile due to news published on the forex factory economic calendar that it would be very difficult, if not impossible, to stay in a trade in order to realize the objective. 

Advantages of Technical Analysis

Technical analysis has been around for as long as there have been organized markets in the form of exchanges. But the trading community didn't accept technical analysis as a viable tool for making money until the late 1970s or early 1980s.

Here's what the technical analyst knew that it took the mainstream market community generations to catch on to: 

A finite number of traders participate in the markets on any given day, week, or month. Many of these traders do the same lands of things over and over in their attempt to make money. In other words, individuals develop behavior patterns, and a group of individuals, interacting with one another on a consistent basis, form collective behavior patterns. These behavior patterns are observable and quantifiable, and they repeat themselves with statistical reliability.

What is technical analysis?

Technical analysis is a method that organizes this collective behavior into identifiable patterns that can give a clear indication of when there is a greater probability of one thing happening over another.

In a sense, technical analysis allows you to get into the mind of the market to anticipate what's likely to happen next, based on the kind of patterns the market generated at some previous moment. As a method for projecting future price movement, technical analysis has turned out to be far superior to a purely fundamental approach. It keeps the trader focused on what the market is doing now in relation to what it has done in the past, instead of focusing on what the market should be doing based solely on what is logical and reasonable as determined by a mathematical model.

On the other hand, fundamental analysis creates what I call a "reality gap" between "what should be" and "what is." The reality gap makes it extremely difficult to make anything but very long-term predictions that can be difficult to exploit, even if they are correct. In contrast, technical analysis not only closes this reality gap but also makes available to the trader a virtually unlimited number of possibilities to take advantage of. The technical approach opens up many more possibilities because it identifies how the same repeatable behavior patterns occur in every time frame—moment-to-moment, daily, weekly, yearly, and every time span in between.

In other words, technical analysis turns the market into an endless stream of opportunities to enrich oneself. 

Technical Analysis Limitations

If technical analysis works so well, why would more and more of the trading community shift their focus from technical analysis of the market to mental analysis of themselves, meaning their own individual trading psychology?

The most likely reason is that you're dissatisfied with the difference between what you perceive as the unlimited potential to make money and what you end up with on the bottom line. That's the problem with technical analysis if you want to call it a problem. Once you learn to identify patterns and read the market, you find there are limitless opportunities to make money. But, as we're sure you already know, there can also be a huge gap between what you understand about the markets, and your ability to transform that knowledge into consistent profits or a steadily rising equity curve.

Think about the number of times you've looked at a candlestick chart and said to yourself, "Hmmm, it looks like the market is going up (or down, as the case may be)," and what you thought was going to happen actually happened. But you did nothing except watch the market move while you anguished over all the money you could have made. There's a big difference between predicting that something will happen in the market (and thinking about all the money you could have made) and the reality of actually getting into and out of trades. We call this difference, and others like it, a "psychological gap" that can make trading one of the most difficult endeavors you could choose to undertake and certainly one of the most mysterious to master.

The big question is: Can trading be mastered?

Is it possible to experience forex trading, stock trading or cryptocurrency trading with the same ease and simplicity implied when you are only watching the market and thinking about success, as opposed to actually having to put on and take off trades? Not only is the answer an unequivocal "yes," but that's also exactly what this blog is designed to give you—the insight and understanding you need about yourself and about the nature of trading. So the result is that actually doing it becomes as easy, simple, and stress-free as when you are just watching the market and thinking about doing it.

Real-Time Technical Analysis


Learning Technical Analysis

Candle Chart Basics


Price levels


Indicators


Strategies

 

 

 

 

 

Categories:  Education