What is technical analysis?

Technical analysis can be a valuable tool to refine your investing strategy, but you need to understand how it works and when to trust it first.

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.

If you’re trying to put your investing strategy together, you’ll have seen a few technical analysis charts around and probably wondered what this whole thing means, why it gives different results with different time frames, and especially what on earth it is based on.

This guide will walk you through the basics of technical analysis. Our aim is that, when you finish reading, you’ll have grasped the gist of it, without the urge to bang your head against the wall.

What is technical analysis?

Technical analysis is a method that tries to predict when it’s a good time to buy or sell a commodity. It can be stocks, currencies, gold – anything for which there is historical price data.

Technical analysis uses statistics to analyse past price movements and volume and other trading indicators; then it says whether the indicators suggest it’s a good time to buy or not.

To a degree, it’s a bit like the robot version of an investment adviser but its predictions and advice are entirely based on past data and statistics.

Wait, what?: The theory behind technical analysis

We can hear you thinking it: “Wait, what? How about all that ‘Past performance is not indicative of future results’ stuff? How about company performance, market trends and all that? Aren’t they supposed to be important factors to decide whether it’s time to buy or sell?”

Well, the validity of technical analysis is based on two theories:

  1. Prices already include all market factors. According to technical analysis theory, you don’t really need to look at how a company is doing or at the rest of the market because the price of a commodity already takes all these things into account. All available information is reflected there, so there’s no point in doing more research or looking at anything else.
  2. Price movements aren’t random, they follow trends. So historic data, if properly analysed, can give information on future performance.

This means that if, for example, something suddenly goes wrong with a company, technical analysis is not necessarily going to reflect it. Technical analysis only works if condition one is satisfied, that is, if market prices reflect all available information. Whether that’s always true or not, is up for debate.

Technical analysis vs fundamental analysis

Not all experts believe in technical analysis and many complement it with its opposite, that is, fundamental analysis.

Fundamental analysis looks at all those “external” factors that technical analysis neglects because it considers them included in the price of a commodity: for example, a company’s performance, its competitors, general market trends, socio-political context and so on.

How technical analysis works

That’s when things get really complicated. Technical analysis looks at a number of different indicators and tools, and if you really want to dive into it, be prepared to spend a lot of time studying the topic.

The first thing to think about is the time frame. Technical analysis tools return different results depending on how long you’re planning to keep the commodities you’re buying. That’s because, for example, if you’re looking at intra-day trading, the performance of a stock throughout the year is hardly relevant; you’d rather learn about the best hours of the day to buy and sell. Conversely, daily oscillations aren’t that relevant if you’re in for the long run.

So, for example, when you look at a one-hour graph or analysis, historic data is being analysed comparing one-hour-long time segments (no, it doesn’t mean that the data is only about the past hour!). This is often shown in a so-called candlestick graph, where each “stick” represents a time segment (in our example, one-hour-long ones) and is coloured in red or blue depending on whether the price went up or down in that period of time.

Once you’ve determined the time frame you want to look at, there is a series of different statistical tools that can be used to analyse the available data, such as moving averages, oscillators and pivots. We’re not going into details (there are books, entire websites and dedicated courses for that), but interpreting those numbers and turning them into investment advice is the main part of a technical analyst’s job.

Does technical analysis work?

This is the million dollar question, isn’t it? The somewhat less-than-satisfying answer is that it can work. Technical analysis is a tool, not a guarantee.

You can use it to your advantage but you need to learn how. For example, different indicators can be more suitable for your investing strategy or for the commodity you’re buying/selling.

If you want to give it a go, keep in mind that there are no guarantees. Don’t expect 100% accurate predictions, nor to make easy money super quickly. Instead, treat it like a set of relevant information you need to filter and understand in order to use it in the best way.

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