In-depth Understanding of Technical Analysis: From Basics to Applications

What is Technical Analysis

Technical Analysis (ТА) — this is an approach to predicting the direction of price movements of assets by studying historical price data and trading volumes. Unlike the approach based on analyzing the intrinsic value of assets, technical analysis focuses solely on graphical patterns and quotation dynamics. Market specialists resort to this method to identify market trends, find levels where an asset may change its trajectory, as well as determine the most favorable moments for entering a position and closing it.

The fundamental principle of Technical Analysis

The main premise upon which Technical Analysis rests is that all information available to market participants is already integrated into the current price of the asset. Therefore, by closely examining price movements and trading volumes, it becomes possible to anticipate future fluctuations in value.

Essentially, technical analysis is the study of the balance of supply and demand, which is reflected in the overall sentiment of market participants. The price of any asset represents the result of the struggle between buyers and sellers, which is inextricably linked to psychological factors — fear of loss and the desire to make a profit.

The most reliable results of Technical Analysis are demonstrated in markets with significant trading volumes and good liquidity. In such markets, the probability of price manipulation is significantly lower, and external anomalies have less impact on the results of the analysis.

The Origins and Development of Technical Analysis

The emergence of chart analysis methods occurred in the 17th century in the trading centers of the Netherlands and developed independently in the 18th century in Japan. However, the systematization and formation of modern methodology are associated with the work of financial analyst Charles Dow, who was also one of the founders of The Wall Street Journal.

Dow was one of the first thinkers to notice the patterns in the movement of individual securities and market indices — they often develop according to expressed trends that allow for decomposition into components and systematic investigation. His concept, known as Dow's theory, served as a catalyst for the in-depth development of the entire spectrum of Technical Analysis.

In the early stages of the development of the discipline, specialists relied on manual calculations and charts created on paper. With the advent of computer technology and software, the methodology has gained widespread adoption and now occupies a central place in the arsenal of professional market participants.

Main Tools: Technical Analysis Indicators

Analysts operate with a diverse set of technical metrics to study price fluctuations and identify moments when it is worth making a trade.

Moving Averages (MA)

There are two main types of this tool:

Simple Moving Average (SMA) calculates the average price over a set period of time. Its function is to smooth out short-term fluctuations, allowing for a clearer view of the overall trend direction.

Exponential Moving Average (EMA) assigns greater weight to recent price data, allowing it to respond more quickly to new information.

The use of moving averages allows traders to establish the dominant direction of market development and localize critical levels. A common technique is to observe the intersection of short-term and long-term averages to obtain trading recommendations.

Relative Strength Index (RSI)

RSI belongs to the category of momentum oscillators and is calibrated on a scale from zero to 100. This indicator measures both the speed and amplitude of price movements. In classical applications, a value above 70 qualifies as a sign of excessive demand (overbought), while a value below 30 indicates a state of demand deficiency (oversold).

Bollinger Bands (BB)

This tool consists of a pair of lines positioned on either side of the moving average. They serve to assess the degree of price volatility and identify situations when the asset is in a state of overbought or oversold.

MACD (Convergence-Divergence of Exponential Averages)

MACD is a momentum indicator that represents the interaction between two exponential moving averages. Its construction includes the MACD line itself, the signal line, and a histogram of the difference. These elements together assist in recognizing potential signals for executing trades.

Interpretation of Trading Signals

Technical analysis indicators serve not only to determine the direction of market movements but also act as a generator of specific signals that indicate when it is appropriate to open or close positions.

Extreme Evaluation Zones: Instruments like RSI can alert to a state when an asset is overly overvalued by consumers (signal to sell the position) or conversely — undervalued (signal to buy).

Moving Averages Crossovers: When the short-term average crosses the long-term average from below, it is considered a positive signal ( known as the “golden cross” ). The opposite scenario - crossing from above to below - is called the “death cross” and is interpreted as a bearish signal.

MACD Signals: The moment when the MACD line crosses the signal line upwards is interpreted as an increase in momentum. A crossover in the opposite direction indicates a weakening of the upward movement.

However, it is important to remember that the accuracy of such signals is not absolute. When conducting short-term operations, indicators can generate a multitude of false informational impulses. To minimize losses, it is recommended to combine Technical Analysis with other approaches and apply strict capital management rules.

Limitations and Critical Assessments

Researchers and practicing analysts express a number of doubts regarding the reliability of the methodology of Technical Analysis, characterizing it in certain aspects as a “self-fulfilling prophecy.”

Circular Logic: It is claimed that Technical Analysis works precisely because a vast number of market participants use identical tools, which generates a predictable market reaction.

Element of Subjectivity: The process of interpreting graphical configurations and price patterns is characterized by subjectivity. This leads to discrepancies in conclusions among different analysts.

Market Behavior in Extreme Situations: The effectiveness of technical methodology is significantly impaired during periods of acute instability or under the influence of unforeseen geopolitical and economic shocks.

At the same time, many traders continue to find practical value in Technical Analysis, especially when combining it with alternative analytical methods. Proponents of this approach argue that each trader has a unique way of reading charts and applying indicators, which excludes the possibility of a universal trading scheme even with the unification of the data used.

Technical and Fundamental Analysis: Differences and Complementarity

Technical analysis focuses on historical price data and chart patterns, while an alternative approach—fundamental analysis—aims to establish the true value of an asset by examining financial metrics, macroeconomic parameters, and qualitative components.

Scope of Technical Analysis: optimal for short-term trading operations, allowing for more precise selection of entry and exit points from a position.

Application of Fundamental Analysis: most suitable for long-term investment programs, as it provides a comprehensive picture of the current state and future potential of the asset.

Many investors practice the synthesis of both methods, utilizing their complementary potential when making key decisions.

Final Recommendations

Considering both the arguments of critics and the logic of supporters, most experts recommend adopting a comprehensive approach. In this context, fundamental analysis serves as the foundation for long-term asset accumulation strategies, while Technical Analysis provides essential information about current market conditions and short-term opportunities, which can be beneficial for both traders operating on short intervals and investors taking longer positions.