Technical analysis is a tool used by traders and investors to determine the probability of a certain price action scenario based on trends and patterns. The basics of this discipline boil down to supply and demand.
Technical analysts determine supply and demand levels from which price could react as well as patterns showing strength/exhaustion of buying or selling pressure. These are then used to build a plausible price projection with specific invalidation points of the scenario in order to take a position in the market and drive capital appreciation.
In order to understand how these patterns form, it is necessary to have a clear image of what price charts represent. A price chart is the representation of every past action of all market participants. Price charts represent the supply and demand of a certain asset. With the acquisition of enough data, technical analysts believe they can determine which prices are considered being a “bargain” and what prices are “expensive”.
Technical analysis mainly employs three different philosophies:
- The first one being that price discounts everything; meaning that whatever news event or other fundamental information is already expressed by the price.
- Unlike the Efficient Market Hypothesis, it assumes that past prices and movements can help determine future prices.
- Price action is always moving in a trend, which can be different on different timeframes.
There are many schools, that fall under the “Technical Analysis” category, that utilise a variety of different tools or a combination of them. Most analysts consider that the most complex one is “Elliott Wave Theory”, it was developed by Ralph Nelson Elliott in the 1930s. Which relates investor psychology to price action and considers every move to either be an impulse or a retracement.