Technical analysis is a methodology used by traders and investors to forecast future price movements based on historical market data. It involves studying charts, patterns, and indicators to identify trends and make informed trading decisions. Unlike fundamental analysis, which focuses on a company's financials and economic factors, technical analysis primarily relies on price and volume data.
How Does Technical Analysis Work?
At its core, technical analysis assumes that market trends repeat over time and that past price behavior can provide insights into future price movements. By analyzing patterns and indicators, traders aim to uncover profitable opportunities in the market.
Key Principles and Assumptions
Technical analysis is built on several key principles and assumptions. These include:
- Market Discounts Everything: Technical analysis assumes that all relevant information about a stock or market is already reflected in its price. This means that everything from news, economic reports, and investor sentiment are already factored into the stock's value.
- Price Moves in Trends: Technical analysts believe that prices move in trends, either upwards (bullish) or downwards (bearish). These trends can be short-term, intermediate-term, or long-term.
- History Repeats Itself: Technical analysis operates on the premise that market behavior tends to repeat. By studying historical price patterns, traders look for similarities that may indicate potential future price movements.
Basic Types of Charts
When conducting technical analysis, traders often use different types of charts to visualize price data. Here are four basic types of charts commonly used in technical analysis:
1. Line Chart
A line chart is the simplest form of charting and displays the closing prices of a stock or market over a specified period. It connects the closing prices with a line, providing a visual representation of price trends.