The debate around the importance of technical analysis continues to ravage the trading world. Is it better than fundamental analysis? The question of the superiority of a strategy does not make sense because each trader has their style or investment profile. What can we blame a person close to retirement who invests in the stock market under the AF base? Or a young trader who does chart trading to generate daily income?
This article is the first episode of our “ technical analysis versus fundamental analysis ” series. In this one, we will focus only on technical analysis.
Technical Analysis: Mastering the Price Curve
Technical analysis is essentially based on the analysis of the price or course of the asset. Its purpose is to identify past asset price histories to determine price scenarios for opening a position. Nowadays, statistical and mathematical forecasting models are widely used to calculate the future price of an asset.
But, in a very practical way, we use Japanese candles to understand the different sequences in the price curve. This curve contains the elements of the opening, closing, high and low of a session.
The four big signals of price analysis
Price analysis goes through four main signals of technical analysis: moving averages (MAs), support and resistance levels, trend lines, and technical indicators. The moving average is used to see if the asset will continue or reverse a trend. It is calculated by taking the sum of recent prices over the number of times taken in the calculation.
As for support or resistance points; traders use these as the moving average to determine the probabilities that favor a price break or reversal. To be able to identify these trends, we use momentum indicators. They are used to measure the pace of the rise or fall in the price of shares. The most used momentum indicators are the RSI, the MACD, and the Bollinger. Finally, trend lines are plots traders make to connect a series of prices.
Technical analysis is fundamentally short-term. This means that it must be able to detect support and resistance levels to open a position as quickly as possible. What good is it to know if Airbnb has a debt of $ 2 billion when the stock goes up daily? Should we not bet on Bitcoin after Janet Yellen’s statement? Despite my chart analysis telling me that the digital asset is in support level to reach a bullish phase?
Many investors analyze stocks to support their fundamentals – like their revenue, valuation, or industry trends – but fundamental factors aren’t always reflected within the market value. The technical analysis attempts to predict price actions by analyzing historical data, mainly price and quantity.
It helps dealers and investors drive the gap between intrinsic value and market value by leveraging methods like statistical analysis and behavioral economics. Technical analysis helps guide traders to what’s presumably to happen given past information. Most investors use both technical and fundamental analysis to form decisions.
Choose the proper Approach
There are generally two alternative ways to approach technical analysis: the top-down approach and therefore the bottom-up approach. Oftentimes, short-term merchants will take a top-down procedure and long-term investors will take a bottom-up approach. additionally, to the present, there are five core steps to getting started with professional analysis.
The top-down approach may be a macroeconomic analysis that appears in the general economy before that specializes in individual securities. A trader would first specialize in economies, then sectors, then companies within the case of stocks. Traders using this approach specialize in short-term gains against long-term valuations. for instance, a trader could also be curious about stocks that broke out from their 50-day moving average as a buying opportunity.
The bottom-up approach focuses on individual stocks as against a macroeconomic view. It includes analyzing a stock that appears fundamentally interesting for possible entry and exit points. for instance, an investor may find an undervalued stock during a downtrend and use technical analysis to spot a selected entry point when the stock might be bottoming out. They seek value in their decisions and shall hold a long-term view of their trades.
In addition to those considerations, differing types of traders might prefer using different sorts of technical analysis. Day merchants might use easy trendlines and volume notices to form decisions, while swing or position traders may prefer chart patterns and technical indicators. Traders developing automated algorithms may have entirely different requirements that use a mixture of volume indicators and technical indicators to drive decision-making.
1. Pick a technique or Develop a Trading System
The first step is to spot a technique or develop a trading system. for instance, a novice trader may plan to follow a moving average crossover strategy, where they’re going to track two moving averages (50-day and 200-day) on a specific stock price movement.
For this strategy, if the short-term 50-day moving average goes above the long-term 200-day moving average, it designates an upward price trend and makes a buy signal. the other is true for a sell signal.
2. Identify Securities
Not all stocks or securities will fit with the above strategy, which is right for highly liquid and volatile stocks rather than illiquid or stable stocks. Different funds or contracts can also require different parameter choices – during this case, various moving averages sort of a 15-day and 50-day shifting average.
3. Find the proper Brokerage
Get the proper trading account that supports the chosen sort of security (e.g., common shares, over-the-counter stock, futures, options, etc.). It should offer the specified functionality for tracking and monitoring the chosen technical indicators while keeping costs low to avoid eating into profits. For the above procedure, a basic description with moving averages on candleholder charts would work.
4. Track and Monitor Trades
Traders may require different levels of functionality counting on their strategy. for instance, day traders would require a brokerage account that gives access to Level II quotes and market maker visibility. except for our example above, a basic account could also be preferable as a lower-cost option.
5. Use Additional Software or Tools
There could also be other features that are needed to maximize performance. Some traders may want mobile alerts or access to trading on the go, while others may leverage automated trading methods to execute contracts on their behalf.
Tips and Risk Factors
Trading is often challenging, which suggests it is vital to try to do your homework beyond the above points. other key considerations include:
Understanding the rationale and underlying logic behind the technical analysis.
Backtesting trading strategies to ascertain how they might have performed within the past.
Practicing trading during a demo account before committing real capital.
Being conscious of the restrictions of technical analysis to avoid costly failures and surprises.
Being thoughtful and versatile about scalability and future requirements.
Trying to gauge the characteristics of a trading account by demanding a free trial.
Starting small within the beginning and expanding as you gain experience.
Technical analysis is not an exact science because forecasting models can be seriously wrong. In reality, it is indeed an art that the one who does it must improve as it goes. You imagine after Bitcoin broke the resistance of $ 60,000, we thought we were in a bullish phase but a day later it drops to $ 52,000. All this is to say that some supporting analysis can lead us to a bull trap.
The Bottom Line
Many investors leverage both basic and technical analysis when deciding purchase decisions since technical analysis helps fill within the gaps of data. By developing an understanding of technical analysis, merchants and investors can improve their long-term risk-adjusted returns, but it is important to know and follow these techniques before committing real capital to avoid costly mistakes.
How could one effectively determine the price of an asset without the macroeconomic context? There is no denying the positive impact of the steepening of the interest rate curve for bank stocks on the stock market. The value of an asset should not be isolated from its intrinsic side. If a stock like GameStop struggled to take off on the stock market last year, it was because of the company’s poor financial results at Covid. So knowing the realities of the business can well help in understanding the trend of the stock market business.