Technical Analysis (TA) is a term used in finance referring to a forecasting method that tries to predict future price and market movements by analyzing market data from the past, mostly price and volume. TA is commonly used on any security, including stocks, futures, (crypto-)currencies, commodities or fixed-income. The only prerequisite here is that historical data is available that can be analyzed.
While the Technical Analysis focuses mostly on recognizing patterns in price movements and recognizing trends, Fundamental Analysis tries to figure out a securities intrinsic value by also evaluating the general economy, earnings, expenses, assets, liabilities and many more.
Main principles of TA
Market discounts everything
According to the Technical Analysis all information regarding fundamental data is already included in and reflected by the current price and can therefore be ignored. The goal here is to understand how other people interpret this information and to analyze the price movements (supply and demand).
Prices move in trends
Probably the most important believe in TA is the assumption that prices move in patterns or trends. This includes short-, medium- and long-term trends. According to this principle it’s much more probable for a price to follow an already started pattern than to break out of it.
History repeats itself
As TA is mostly based on market psychology, the last principle states that history repeats itself. In detail the principle claims that price movements and patterns repeat themselves over a long period of time. It is based on the irrational emotions of investors created by fear or excitement.
In summary TA focuses mostly on the market forces supply and demand. As market data becomes more and more complex traders usually use statistical and mathematical approaches to create indicators to act upon.
Traders using TA try to forecast future price movements. Indicators to recognize those include chart patterns, price trends, volume and momentum indicators, oscillators, moving averages and support and resistance levels to name the most common ones. TA indicators are commonly used to create buy and sell signals for traders to act on. Especially in recent years with the rise of Artificial Intelligence (AI) these indicators gain importance as they deliver statistical data that can be interpreted and used by trading algorithms.
Especially in the cryptocurrency sector TA has big limitations. First of all the low volumes and market caps of most projects can lead to high volatile markets that can easily be manipulated by a single investor. Secondly the data available to use for that kind of analysis is usually little and doesn’t reach back far enough to recognize long term trends. Finally most of the assets in a currency are still held by few investors which gives them the opportunity to manipulate prices and volumes.
Looking at general security markets TA sometimes creates a self fulfilling prophecy. A lot of TA traders will put their buy and sell orders according to the patterns they start to recognize. The more traders act like that the higher is the probability that this pattern will show up in the end as many traders will act according to it already.