Restrictions And Reactions Of Technical Analysis
What is Technical
Analysis?
Before investing in the financial markets , you
must determine how you will find the best investment opportunities. Best Trading Course in Australia ,technical
analysis and fundamental analysis are the two most popular types of market
analysis. Let's see how technical or chart analysis works and what are its
limitations.
Technical analysis –
definition
In trading , technical analysis is a method used
to identify trading opportunities based on stock price action, trading volume,
and other statistical and mathematical information.
Technical analysis – which works on all types of assets such
as Forex , stocks , indices, commodities and more
– allows:
to identify significant price levels;
to detect chart patterns supposed to show signs of
trend reversal, indecision or continuation of the current trend;
take advantage of relevant trading signals in the short
term.
3 examples of technical analysis
Support and Resistance
A support materializes a level concentrating a strong demand causing
the pause of a bearish movement or the reversal of a bearish
trend . Upon contact, prices rebound temporarily or
permanently. If the price breaks a support, then the bearish movement
accelerates towards the next level of support.
Trend Line
For technical analysts, prices always move in a
trend . It can be bullish, bearish or neutral. A trend line is
therefore a line that links a series of prices to highlight the direction that
a given asset is taking .
An ascending trend line characterizes
an uptrend and follows higher and higher highs and lows. In this
case, prices will be above the trend line.
A descending trendline represents
a downtrend with lower and lower highs and lows. In this case,
the prices will be below the trend line.
Overbought and oversold
situation
There are many technical mathematical indicators to rely on
in technical analysis. Some make it possible to highlight overbought
or oversold situations such as the relative strength indicator (RSI
technical indicator ) or the Money Flow Index (MFI) .
These extreme price situations represent areas in which
the price tends to turn around : downward in the case of an overbought
zone or upward in the case of an oversold zone. This makes it possible
to identify opportunities when the buying or selling pressure is too
great on an asset.
Limitations and
criticisms of technical analysis
There are 3 main principles on which technical analysis is
based:
prices reflect all information available at any given
time
assets are always trending
The story repeats itself
Technical analysts therefore consider that only the study of
price movements and the use of technical indicators are necessary to know when
to enter and exit the market. Prices indeed give you all the necessary
information about investor sentiment and potential future price
movements. However, there are certain criticisms and limitations regarding
the principles that govern technical analysis.
First, many critics of technical analysis are unconvinced by
Fama's market efficiency hypothesis. To consider that all available and
relevant information regarding the forces that govern the supply and demand of
an asset is instantly factored into the price would be a flawed process of
analysis. Thus, taking into account the evolution of stock market prices
by thinking that they integrate all the information available to predict the
direction that an asset will take would not work.
Finally, some believe that technical analysis works
primarily because it is a self-fulfilling prophecy. This concept refers to
the fact that a market movement will only occur because it is anticipated by a
large number of traders who place orders at a certain price level. Since
the behavior of market participants is impacted by this anticipation, the
consequence is that this event occurs.
Technical
Analysis vs Fundamental Analysis
Two camps compete when it comes to determining the best way
to analyze the markets to take advantage of the opportunities that
arise. This is technical analysis vs. fundamental analysis.
While technical analysis is based on the chartist study of
an asset's prices, fundamental analysis does not at all consider the evolution
of an asset's prices. Rather, it will take into account fundamental
factors concerning the asset in question. The idea is to be able to
determine its intrinsic value to know if it is currently overvalued or
undervalued by the market and take advantage of it.
If you are a fundamental analyst and you invest
in S&P 500 stocks , for example, you will focus on financial data
and ratios that will analyze:
the performance of the company per se or
compared to its peers (sales, profits, turnover, margin, etc.)
its growth prospects
their level of indebtedness
its dividend
its development projects
the return on its shares
Beyond information about the company itself, you should also
consider data related to the following:
the sector of activity in which it operates
the state of the economy as a whole
the evolution of exchange rates if the company is present in
several markets
the competitors
commodity price changes
changes in regulatory, tax, monetary and fiscal policies
Read More: Stock Trading Education
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