Technical
analysis can be defined as a method that attempts to forecast future
price trends by the means of analyzing market action. It was established
as early as 18th century. However, most of its methods as we know them
today were created in the first decades of 20th century. The core idea
of technical analysis is that history tends to repeat itself. That is
why we can find certain situations in the market that occur regularly.
These situations can be discovered by chart analysis and technical
indicators, which we can use for our advantage – and that is precisely
what technical analysis is trying to do.
There
are several approaches to technical analysis – such as the Dow theory,
Elliot wave theory, Fibonacci's analysis, cyclical analysis and so on.
The most commonly used methods can be divided into two major branches –
namely chart analysis (also called charting) and statistical approach.
With chart analysis, the analyst is trying to find patterns that price
creates in the chart and that occur repeatedly. For example, head and
shoulders or double bottoms are considered typical chart patterns. As
soon as the analyst identifies such a pattern, he can make a trade based
on the direction the price should follow based on the type of the
pattern.
Another
branch of technical analysis is constituted by the statistical
techniques, which comprise mostly the study and use of various technical
indicators. These indicators are computed from historical market data
and are mostly used for forecasting trend reversals or changes in
strength of the trend. Many of the indicators yield precise buy and sell
signals. There are several kinds of indicators – from the very simple
ones like moving averages to the very complicated such as Swing index,
for which the mathematical formula is several lines long.
It
is the job of the technician to know how to use and which indicators to
use, so to best figure out and plot the future path of the markets.
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