A Guide to the Basics of Technical Analysis in the Markets

Definition and Basic Principles

Technical analysis is an approach to predicting changes in asset prices by studying historical price data and trading volumes. This method differs from the fundamental approach, which analyzes a variety of macroeconomic and microeconomic factors. Traders and investors use it to identify market trends, determine critical support and resistance levels, and find optimal moments to open and close positions.

Historical Roots of Technical Analysis

The emergence of this method began in the 17th century in the trading centers of Amsterdam and later developed in Japan in the 18th century. However, the modern understanding of technical analysis is associated with the works of financial analyst Charles Dow, editor of The Wall Street Journal. Dow was one of the first to identify the pattern that asset prices move according to certain directions, which can be divided and systematized. His theory, known as Dow's theory, served as the foundation for the further development of the discipline.

In the initial stages, specialists relied on manual calculations and hand-drawn tables. With the advancement of computer technologies, the tool became more accessible and gained widespread adoption among professional and private market participants.

The Mechanism of Technical Analysis

The hypothesis is based on the idea that all available information is already reflected in the current quote. By studying graphical patterns and volume dynamics, analysts attempt to predict future price movements.

The essence lies in the study of the relationship between supply and demand, which reveals the psychological state of market participants. The pricing of assets depends on the competing forces of buyers and sellers, closely tied to the emotional state — the fear and greed of investors.

Technical analysis demonstrates maximum effectiveness in liquid markets with high trading activity, where standard operating conditions contribute to objective price formation. In such markets, the influence of manipulation on quotes is minimal, and the results of the analysis are less susceptible to distortion.

Key Tools for Quote Analysis

Moving Averages (MA)

The Simple Moving Average (SMA) calculates the average price over a selected period, helping to smooth out short-term fluctuations. The Exponential Moving Average (EMA) gives more weight to the most recent quotes, making the tool more responsive to new data.

These tools help identify the direction of the main trend and highlight support and resistance zones. A popular method uses the crossover of fast and slow moving averages to generate trading signals.

Relative Strength Index (RSI)

This is a momentum oscillator that evaluates the rate and magnitude of price changes on a scale from 0 to 100. A value above 70 is traditionally interpreted as overbought, while below 30 indicates that the asset is oversold.

Bollinger Bands (BB)

The system consists of two bands located on either side of the moving average. It allows for the assessment of market volatility and the identification of extreme asset valuation points.

MACD (Moving Average Convergence Divergence)

This indicator tracks the dynamics between two exponential moving averages and includes a main line, a signal line, and a histogram. The combination of these elements helps to identify potential trading opportunities.

Trading Signals and Their Reliability

Technical analysis tools are used to identify entry and exit points:

• Extreme Conditions: RSI-type oscillators signal overbought (possible sell signal) or oversold (possible buy signal).
• Moving Average Crossover: a bullish signal is formed when the short moving average crosses above the long moving average (golden cross), while a bearish signal occurs with the opposite crossover (death cross).
• MACD Signals: the crossing of the main line of the signal from top to bottom may indicate an upward momentum, while from bottom to top may indicate a downward momentum.

It is necessary to understand that signals are not infallible. Over short time intervals, indicators often generate false signals. To minimize losses, it is recommended to combine technical analysis with additional risk management methods and verification of data in multiple ways.

A Critical Look at Technical Analysis

Opponents of the method call it unreliable and a “self-fulfilling prophecy” — a phenomenon in which an event occurs because most participants believe in it.

Main critical remarks:

• Self-fulfilling prophecy: skeptics suggest that the analysis works solely because many traders use identical tools, creating a predictable market reaction.
• Subjective element: charts and patterns are subject to various interpretations, which is why analysts come to different conclusions.
• Impact of Market Anomalies: effectiveness decreases during sharp volatility spikes and when influenced by unforeseen events.

At the same time, many market participants continue to consider technical analysis a valuable tool. Proponents argue that each trader has an individual approach to interpreting charts and indicators, so a universal strategy cannot exist given such a variety of methodologies.

Comparison of Technical and Fundamental Approaches

Technical analysis relies on historical quotes and visual patterns, while the fundamental approach assesses the real value of an asset through financial statements, economic indices, and qualitative parameters.

• Technical method: most effective for short-term trading strategies, helps to identify optimal entry and exit points.
• Fundamental method: better suited for long-term investment decisions, evaluates the prospects and condition of the asset.

Professionals often combine both approaches to make informed decisions.

Final Recommendations

Considering the arguments of both sides, most experts recommend adopting a comprehensive approach that combines both methods. Fundamental analysis will serve as the foundation for a long-term investment plan, while technical analysis will provide timely information on the current market conditions and short-term price movements, useful for both traders and investors.

It is important to remember: technical analysis is a tool that requires continuous improvement of skills, careful verification of data through multiple methods, and the mandatory application of capital protection strategies. Success depends on a combination of knowledge, experience, and discipline.