Technical Analysis is the study of the price movements of any asset that is likely to have a price, and that not only includes financial assets, but also things such as sports betting odds, for example.
However, it is in financial markets that technical analysis acquires the crucial importance that elevates it to the almost religious category, since in a way this technical analysis becomes the Bible on which day trading is based.
That is to say, it is almost inconceivable to think of trading of any kind if it is not done by applying some technique of technical analysis, however simple that may be.
I have named the term “day trading” because it is in the same place where the technical analysis acquires its maximum expression, being that where the market priests (technical analysts) apply or try to apply their knowledge.
Obviously, technical analysis, being a “science” of study of prices and graphics that the previous draw, we can apply in all types of graphics; not only those dedicated to short-term or intra-day trading.
This technical analysis, in theory, serves for all kinds of temporalities, whether they are 5-minute bars, 1 hour, 1 day, 1 week or 1 month.
I say, at least in theory, because in practice the thing is more complicated to discern, or at least to try bluntly.
We can say that this analysis is the same for a 10-year chart as for a one-day chart, because in the end the patterns that can occur are the same, but we have to think that one thing is to say it, another is to see a valid example, and another is to prove it bluntly. The latter, obviously, we cannot do it.
That is why some analysts say that long-term charts present better cases of non-randomness than short-term charts.
Objective of the Technical Analysis
Therefore, technical analysis is what traders use to try to predict where the prices of assets will go, and thereby earn money in a consistent manner.
That is to say, that with this analysis the traders will try to find price patterns with which they can make money in a consistent way in the markets; because it is assumed that there are patterns in the market that are repeated over time.
The ultimate goal of mastering the techniques of technical analysis is to make money, make no mistake.
Therefore it is not a suitable ground for those who are afraid of losing money or who are not good at doing it, because we can be sure of one thing: whatever the technique we choose, we will have losing streaks in which we are going to lose money. Neither professional can avoid this. So if you do not get along well with losing money, do not get in this world.
Markets to which technical analysis applies
The markets par excellence of this “science” are the financial ones, such as:
- Stock indices
- Foreign currency FIAT
- Cryptocurrencies(digital currency)
- Bonds, Fixed Income and derivative securities (Swaps, etc.)
But as I said at the beginning, we can also apply it to other markets, which although they are financial, have other niches as an activity that explains them better, such as bets, which can be:
- Odds on sports
- Odds on political events
- In general Odds on any betting market that we can imagine
Of the latter, the technical analysis of sports betting is the one that has gained most popularity in recent years.
Fundamentals of technical analysis: graphs and indicators
Well, before going to the two fundamental pillars that are used to try to apply strategies based on technical analysis, I will remember the bases on which these pillars are based:
- The price
- The volume
Of these two variables, the price is the main one and responsible for, I would say, 98% of the technical analysis that is done in the world. However, we cannot forget the volume, which is also a market variable, because in each price tick, we always have an associated volume.
Once we have well established these bases we go to erect the pillars that we will use to apply the possible techniques of technical analysis, which can be infinite, because endless are the possible combinations.
These two pillars that are used for technical analysis in the graphs are: the technical indicators and the patterns in the graphs.
These indicators are the most widely used tool, by far, in the application of technical analysis strategies at present.
Because they are the result of quantitative mathematical calculations and, therefore, present “objective” data
What I mean by this?
That the calculations of the indicators will always give us a certain measurable number that varies as the periods vary, and therefore we can make quantitative studies that are perfect (or almost) about them.
This is important because if we have noticed, the current world is increasingly entering the field of quantitative, dominated in a brutal way by the so-called Artificial Intelligence, which is nothing other than the automation of things and that in trading it is translated into the automation of possible strategies.
This automation is done in a perfect way with the technical indicators, with what we have that the great majority of students of the technical analysis of today, especially in its technological aspect, use automations of indicators of this type.
In the past times of trading, when the systems were not so automated and the graphics had to be drawn by hand, the qualitative character, more predominant, for example, in the “graphics patterns”, still weighed more.
What are the main technical indicators?
In the first place we will have to differentiate these indicators between indicators of: trend, oscillators, and volume
I’m going to name the principals of each section
As its name says, these indicators are used to try to know when we have a possible market trend.
The main ones are:
- Bollinger Bands
- Trading channels
- Moving averages
- Parabolic SAR
- Standard deviation
As the name indicates, here we would be looking for moments of “change”, because oscillating indicates that we are moving from one situation to another. On the Stock Exchange, these two situations that traders try to guess and find are: overbought and oversold.
The main oscillating indicators are:
These are, obviously, related to the volume and variation thereof with respect to time.
The main ones are
- On Balance Volume
- And, of course, the volume by itself
This is the second pillar of Technical Analysis, being in this case the most “qualitative” type pillar.
Because in this case it will be more difficult to determine exact numbers, although in some of the elements we can do it, such as supports and resistances, which are, on the other hand, the two most famous patterns of technical analysis.
Now, one thing is to be able to quantify the resistance X and another thing is to try to look for a quantitative automation strategy to be able to use a strategy based on this resistance.
To see it with an example, if we have an RSI we can apply an automated strategy based on it without problem. We can buy when the RSI is higher than 50 or 90.
However, if we have a resistance in 150, because that is the price in which we see the previous one in the chart, we cannot use an efficient automated strategy with it because these resistances vary as the price varies and new maximums are formed. Today it can be 150, 850 years from now.
In this way we can see that the graphics patterns are something that we have to apply more to the eye.
What are the main graphics patterns?
- Supports and resistances
- Ascending and descending triangles
- Symmetrical triangles
- Shoulder head shoulder (and inverted)
- Double roof
- Double floor
- Price ranges (channels)
Advantages of Technical Analysis
Undoubtedly, the most important variable in technical analysis is price, which revolves around the ecosystem of indicators and market patterns.
Since prices can go from 10 to 1,000 in certain assets, we cannot apply quantitative trading techniques since both ends are very different in quantity. However, when applying the corresponding formulas we can find an RSI of 50 when the price is at 10, and also of 50, when the price is at 100 a few years later, with which we already have a “measure” with which to work.
Search for qualitative patterns
In spite of what has been said, the analysis not only stands out quantitatively, but also qualitatively, in the sense that we may find similar occurrences in assets of the same category, especially when they recur in a more or less cyclical.
For this we can study things like maximum, minimum, openings, closures and volumes, and according to what “we see” try to assign a kind of “price action”. This last term is one of the favorites of the market and is used by many experts in the sector. What does not mean that it is easy to handle, especially because we are in a “qualitative” field.
It helps you find entry and exit points
This is my favourite utility in this field.
Because technical analysis helps me to dissolve the doubts I may have at certain times.
Well, with the technical analysis these doubts are cleared, because either quantitatively, when the RSI is 40, or qualitatively, when the resistance of 80 Euros is exceeded, I can determine the points where I will buy or sell .
If not, it is something that you will simply be doing intuitively, which is not recommended, because random buying and selling at the end of the day takes you to a safe ruin.
Even legendary traders like Jesse Livermore, used some criteria of technical analysis, such as waiting for stock market ruptures, which was when he liked to buy or sell.
Disadvantages of technical analysis
Some say that technical analysis has a big problem, especially when applied in the short term, which is nothing but the randomness of it.
I will try to give you a simplistic example on the subject but I hope it helps you to understand.
Imagine that we have the EURUSD for a couple of years, in which the price has increased by 10%: from 1.20 to 1.32.
However; during those two years if we add all the bullish ticks and the bearish ticks we may have had an accumulated 1 trillion percent cumulative tick rise, and an accumulated drop of bearish ticks of approximately 1 trillion percent (minus 10% of previously commented upload).
Do not you see that in the end, in those movements of ticks, or 1 minute candles, for example, in the short term, in the end we have a kind of movement that is compensated between the ups and downs?
Well, if you see it, that gives these short-term movements a rather strong random character: a character from which it is difficult to escape.
The indicator is too late
One of the things that happen with this indicator is that they tend to faial many times, because in the end we realize that many times when we give the signal to buy or sell is too late. The funny thing is that sometimes it is not.
You can identify a possible trend, but in many cases we may “ride” when it ends.
The theory is not the same as the practice
It is assumed that the technical analysis has some standards.
The problem here lies in an important issue: if all analysts are guided by the same standards, then we will have an impossible market, because for there to be an efficient market there must be buyers and sellers.
I suppose you will think that in this case the ready ones will be the analysts and the not ready those that are not.
But believe me, when everyone tries to follow the same rules in the markets, in the end we are in a situation of traffic jam.
We will have to seek to get out of the “norm” thought, so to speak.
The technical analysis has endless possibilities and that makes you have no limit when it comes to studying it, being able to apply as many strategies as we have in our minds.
However, it is likely that in the end such analysis is not enough to be able to achieve a long-term competitive advantage in this dynamic and complicated activity such as trading.
My advice is that you should study the fundamental characteristics of the market you are negotiating in the first place. This is because some markets have some characteristics and others have others, and that is crucial when applying different techniques based on technical analysis.
Moreover, you will also have to apply advanced trading techniques that are complementary to technical analysis, without which we are totally defenceless against market sharks.
To summarize, technical analysis is effective, but you will have to combine it with other types of analysis and techniques, which cannot be learned in a quantitative way so easily.
Greetings and good trading
Original article: Análisis Técnico