By Ryan Watkins, Lead Coach
Technical analysis has been around for an exceptionally long time. In fact, Joseph de la Vega talks about it in his book (the first book ever written on the stock exchange business in 1688). It is used by traders and investors of all levels. From famous traders to hedge fund managers to professional traders, to everyday traders, to novice traders.
Many of you reading this may be using technical analysis. If you’re new to trading and investing, you may be wondering just what is technical analysis. In this article, I’ll go through what it is, show you some examples. and explain the pros and cons.
What is Technical Analysis?
Technical analysis is the analysis (or study) of market movement, mainly through the use of charts, chart patterns, volume or other indicators for the purpose of predicting future price direction.
Types of Technical Analysis
- Chart (Price) Patterns such as Trend Direction, Flags, Pennants, Head & Shoulders, Double Tops, Double Bottoms, Cup & Handle, Support, Resistance, Supply Areas, Demand Areas, and much more.
- Indicators such as Moving Averages, MACD, Oscillators, Momentum Indicators, Volume, Fibonacci, etc.
- Psychological/Theory-Based such as Dow Theory, Elliott Wave Theory, Relative Strength, and more.
An example from the 1960s
The S&P 500 ($SPX.X) is a major market and the largest equity market in the world. One classic Technical Analysis Chart Pattern is an “Oldie but Goodie”, Old Resistance becomes New Support. Here at StockAbility, we call these price areas Transition Zones. These are used to place buy orders when either price breaks out of the Resistance Area or when price returns into the Support Area. In this example of $SPX.X, you can see a Transition Zone right after July of 1963.
Examples of recent Technical Analysis
In a more recent example, November 2020, the EURUSD Forex Pair is displayed in a 30-minute chart. Meaning, each Blue & Red Candlestick is 30 minutes of trading data. Traders that use Technical Analysis would use chart patterns like these to trade. There are several to choose from, Head & Shoulders Reversal Pattern, Double Top Resistance (Supply) Transition Zone Support (Demand). Reversal Pattern, Double Bottom Reversal Pattern, and Transition Zones. Traders use Technical Analysis because these, and many more patterns show up repeatably on every market and offer consistent trading opportunities.
The Cons of Technical Analysis
Ok, let’s start with the cons first:
- It takes time to learn and there are many types of patterns, indicators & oscillators.
- The learning curve is not easy. Many traders take months or years to get good at their trading skills.
- Some work better than others. Some work best with other patterns, time frames and some work best using multiple time frames and that can get confusing and difficult to learn.
- A lot of trading companies disguise Technical Analysis patterns with stimulating words that work well in marketing, but ultimately are simply just another form of price pattern information. Unless you know the patterns, you may fall into that trap.
The Pros of Technical Analysis
Now, let’s look at the pros:
- Chart patterns happen very often with a predictable outcome. Traders that are seeking consistency or a criterion to trade may find Technical Analysis patterns particularly useful.
- Many patterns can be backtested before a trader uses them.
- Technical Analysis can be used on any market and any time frame.
- It is easy to find information. Many books, blogs, and articles have been written on the subject.
- Because so many people are using it, looking for specific patterns in the chart, traders buy or sell based on what they learn. Technical Analysis is immensely popular and is one of the two dominant factors of trading or investing. Fundamental analysis is the other.
One of the most reliable pros of Technical Analysis is that was happening long before traders even knew about it. For example, in the 1800s, you can see price patterns that are the same patterns that are traded today. Why? Because humans are doing the trading and we trade based on beliefs, emotions, and thoughts, not just a price pattern. It just so happens that these beliefs, emotions, and thoughts are the same in humans today as they were since the start of trading exchanges.
We, humans, are predictable with our thoughts, we can see the actual pattern shape of our buy and sell decisions in the form of a price chart. In other words, our greed, fear, and other emotions are predictable. These predictable emotions are shown in buy & sell orders on the charts. We, humans, want to trade something we feel comfortable trading, so we rely on chart patterns we are familiar with. Trading is more psychological there most people realize.
The bottom line is that trading using Technical Analysis can be very useful, but it takes time to learn and you don’t need to learn all of it. In fact, at StockAbility, we teach that you only need to master a small handful of price patterns to do well in this business. Our students learn all about these in our FoundationalAbilites Course.