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A popular way of analyzing the markets is through technical analysis. This method uses charts to study price movements based on information from the past. The purpose of technical analysis is to forecast the future direction of prices. We will be looking at the various tools and techniques used in this type of analysis.
Principles of Technical Analysis
Three key principles form the basis of technical analysis
- Market action discounts everything
- Prices move in trends
- History repeats itself
Market Action Discounts Everything
This fundamental principle of technical analysis is the belief that a market’s price reflects all relevant information. This means that anything that can possibly affect price, such as economic, political, social or psychological factors, have already been taken into account by the market. All reactions of traders to such factors are represented in the charts.
Prices Move in Trends
Technical analysts believe prices move in trends and as such their goal is to identify the existing trend and follow it. This principle originates from the Dow Theory. The three main trends of price action are: up, down and range.
History Repeats Itself
Another basic premise of technical analysis is that investor behavior tends to repeat itself over a period of time. Technical analysts believe that this behavior will create identifiable price patterns on a chart which can be studied to predict similar future price patterns.
