Trading Toolkits: Technical Analysis Explained

Technical analysis (TA) has been used for close to a century and it is still used in modern-day markets, such as crypto markets.

By
Greg Gotsis
on
February 13, 2021
Category:
Trading Toolkits

What is Technical Analysis?

Technical Analysis (TA) is a trading method that revolves around analyzing past market data market, typically in the form of charts. Traders utilize TA in nearly all financial markets to obtain an edge through price and volume data. TA was first popularized in the late 1940s, and since then, it has been one of the most used tools in trading.

This method differs from fundamental analysis (FA), which relies on factors such as sales, earnings, and other macro-economic backdrops to evaluate a securities value. This is opposed to technical analysis, which strictly uses price and volume data integrated with a plethora of analytical strategies that revolve around price charts. TA is best used in short to mid-term timeframes as it allows users to gather information on the supply and demand of an asset and speculate on the next movement of it. Many also apply this analysis technique in finding the overall strength and weaknesses of assets compared to other sectors of the market; these traders would utilize high time frame charts such as Daily, Weekly, and Monthly.

Early Theory

As previously mentioned, TA arose in the late 1940's and some of the largest contributors to the field were Dow, Hamilton, Rhea, Gould, and Magee, who all introduced aspects of modern-day TA theory. These pioneers begin through hand charting and data calculation, which has tremendously evolved as we've entered the digital age. While some of these principles are outdated, the core fundamentals have seemed to hold even in modern-day cryptocurrency markets.

For those who wish to learn more about the pioneers of TA, check out the following Investopedia article:

The Pioneers of Technical Analysis

Basics of Technical Analysis

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The fundamental aspect of TA relies on the fact that traders assume past price and volume data are valuable in speculating future price moves. This consists of all sorts of methods and tools which traders can access to capitalize on the given data. Typically, large scale traders and investors don't rely on FA or TA soley; many successful traders incorporate a blend of both. On the other hand, there are a plethora of extremely successful traders who integrate only one type of analysis.

TA relies on a few assumptions from Dow Theory, which build out the core concepts of how to execute TA:

  1. The Market Discounts everything – This assumes that everything in markets is already priced in, such as broad market factors and market psychology. This leaves any other speculation and asset movement a direct product of supply and demand.

Editors Note: I argue this is not the case, and the fact that not all aspects of markets are priced in results in large amounts of edges to be realized.

  1. Price Moves in Trends – This core aspect of TA revolves around one of the most popular trading strategies, trend following. Prices seem to exhibit trends that can been seen on charts, allowing traders to capitalize on patterns. The assumption is that prices are more likely to trend than move sporadically
  2. History Tend to Repeat Itself – This is a core aspect of TA as all data referred is past price and volume data. Technical Analysts trade on the idea that markets exhibit repetitive nature, which can be accredited to market psychology, such as fear and greed. These assumptions are since humans show patterns that display themselves in financial markets.

Application of Technical Analysis

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As time has progressed, traders have adopted strategies beyond classical chart patterns and basic market structure. A very common TA method that traders employ is the use of indicators and metrics to understand trends better. One large class of indicators consists of moving averages; simple moving averages (SMA) and exponential moving averages (EMA) frequent the most in trading strategies. These indicators calculate an average price using the closing prices of an asset within a certain period. EMA's go a step further, weighing the most recent closing prices more heavily than the previous. 

Another popular type of indicator is oscillators; one of the most used is the relative strength index (RSI). Oscillators differ from moving averages as they apply mathematical formulas to price data, which spit out reading that fall within a pre-defined range. As for the RSI this range is from 0 to 100, typically representing if an asset is overbought or oversold.

These are only a couple of technical indicators used in trading out of the thousands available to traders. Indicators are not the holy grail to trading, but they can serve as powerful tools to traders who can incorporate them into their strategies. Typically traders will combine indicators with other technical analyses such as price trends, chart patterns, and support/resistance levels. This makesup what is known as a market structure that nearly all technical traders utilize.

Overall, technical analysts look at a plethora of things depending on each individuals edge:

Technical Analysis Drawbacks

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While technical analysis is widely adopted, it is a controversial topic among many professionals in the space. One argument often brought up that it goes against the efficient market hypothesis in the sense that there should be no actionable data that is not priced into markets, including price and volume data. 

Critics will also argue that TA only works as some sort of "self-fulfilling prophecy," the more people who adopt the thinking enable it to work. In the scope of financial markets, many argue that since numerous traders rely on similar support/resistance lines and indicators, the chances of success increase.

In contrast, most TA traders will argue that each trader can analyze charts and indicators to find an edge. At the end of the day many traders find success in only using TA on top of the plethora of successful traders who incorporate both FA and TA.


Fundamental Analysis vs Technical Analysis

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As mentioned, Fundamental and Technial analysis represent two schools of thought which nearly all investors and traders fall into. Both methods incorporate research to forecast the market's future trends, whether short term or long term. Ideally, market participants can incorporate aspects of both into their trading strategy to maintain an edge in markets.

Fundamental analysis focuses on pricing an asset's intrinsic value by studying the overall economy and industry conditions. Traditional fundamental analysis can be tied to earnings, expenses, assets, and liabilities of the stock or company that is being invested in. In De-Fi markets, users use indicators such as Total Value Locked (TVL), Annual Percentage Yield (APY), and Market Cap (MC), among a plethora of others.

A large difference between the two is that fundamental analysis aims to value the asset, telling the investor/trader whether the asset is undervalued vs overvalued. As for technical analysis, traders focus on market charts to predict price action or behavior. Overall, both strategies are ways that traders speculate on market moves in modern-day financial markets.


Conclusion

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Technical analysis has been used for close to a century and its still used into modern-day markets, such as cryptocurrencies. TA provides traders with past market history allowing them to speculate on patterns and market structure using price and volume data. Many traders rely on TA as a crucial aspect of their trading strategy alongside other analysis techniques. Charts are a powerful tool as they also allow traders to set defined Risk:Reward profiles in their speculations. Overall, TA has rooted itself into the core of markets alongside FA; ideally, a trader will be able to incorporate both thoughts in constructing a profitable trading strategy.

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Greg Gotsis

Greg is a co-founder of BSC News and Solana News. He is also the current editor in chief where he pursues crypto and decentralized finance research. In his free time he finds himself in nature, surfing, or learning piano. His bags are heavy with Solana NFTs, CAKE and multichain DeFi protocols.

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