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When we first started trading, we put in a lot of effort to beat the market average, which you could easily do by simply investing in a standard index fund. Using technical analysis to determine when is the ideal moment to invest in the market is a frequent way to beat the market. Do technical analysis really work?
Technical analysis may, in fact, outperform the market. However, it’s crucial to remember that technical analysis is just a tool for defining and quantifying market activity, not a source of solutions. It is up to us, as traders and investors, to make good use of the data that our technical analysis tools give.
Technical analysis (TA) is viewed by some traders and investors as a shallow examination of charts and patterns that yields no tangible, convincing, or lucrative findings. Others say it is akin to the Holy Grail, and that mastering it will result in massive wealth. Misconceptions regarding technical analysis and how it is utilized have arisen as a result of these competing perspectives. But do technical analysis really work?
Some technical analysis misunderstandings stem from a lack of education and training. For example, a trader who has exclusively used fundamentals may have little faith in technical analysis. That isn’t to say that someone who has been schooled in technical analysis can’t make money with it. Other legends are based on personal experience. The improper use of technical indicators, for example, frequently results in losses. That isn’t to say the approach isn’t effective; perhaps the person simply needs more experience and instruction. Other illusions are perpetuated by marketing, which promises instant profits if you buy and apply a simple indicator. It’s seldom that simple.
What is technical analysis?Technical analysts purchase and sell stocks based on historical stock price movements, trade volumes, and investor sentiment. Sales growth, profitability, debt and cash on the balance sheet, and the industry in which a business works, according to proponents of technical analysis, are already priced into the company’s shares. A technical analyst could forecast a similar future price conclusion for two very different firms if their history charts are comparable.
misunderstandings about technical analysisOne of the most vehement objections of technical analysis is the notion that previous prices cannot be used as a predictor of future prices. However, there is a significant problem in that reasoning.
Anyone who has ever bought a stock knows how stressful it can be to see a position’s gains or losses grow. It’s in our nature. This is a strong indication that entrance costs have some influence on future behavior. Remember that we evaluate our success by comparing the current price of a stock to the price at which we bought it, and those entry prices are past prices. It’s naïve to believe that past prices don’t have an influence on how a stock trades in the future. After all, investors’ entry prices have a lot to do with their final decisions to liquidate their holdings (or purchase more).
It isn’t necessary that previous prices magically translate into future prices. Past prices are crucial because they are the greatest method we have for identifying supply and demand in the market.
Technical analysis has not always received favorable treatment in academics. Technicals can’t work, according to popular financial and economic concepts like the Efficient Market Hypothesis and Random Walk Theory.
However, most accademia overlook the fact that under such models, basic analytical methods are also ineffective.
The notion that technical analysis isn’t employed in big funds or institutional contexts is a frequent one, but it’s also false. While fundamentally driven funds dominate the institutional scene, virtually every major institutional investing company includes a technical research department, and all institutions have trading floors staffed by technical traders.
why would you want to use technical analysis in your investment?Regardless of what others may tell you, prices are only affected by two factors. It’s just supply and demand – nothing more or less.
When demand for a product exceeds supply, prices increase. In the event that supply exceeds demand, prices will fall. In the foreign currency market, this is true.
The factors that influence supply and demand in the foreign exchange market might be debated for hours. Is it the difference in interest rates? Is it because of yield curves? Data on inflation? Do you have any employment statistics? The intriguing issue is that no one can be certain why people are buying and selling currencies at any one time. This is where technical analysis shines.
Technical analysis never tries to figure out why supply and demand exist, just that there are specific amounts of supply and demand. We can establish, to a large extent, what the current levels of supply and demand for a currency are, what market players may be thinking, and so analyze the currency pair as a transaction by examining real price movements.
The merit of technical analysis is that it allows you to buy and sell based on current prices rather than depending on future value theories based on central bank pronouncements, yield curves, and other factors.
Technical analysts think that all fundamental and economic impacts on the price of a currency have already been factored into the market, therefore all they have to do is watch the price activity. Many technical analysts go so far as to say that fundamentals are irrelevant and should be ignored entirely. To put it another way, the price tells you all you need to know about the product.
Despite the passage of time, human nature and behavior have remained consistent over the years. All market players are motivated by comparable emotions and will frequently react in the same manner to events. Technical analysts learn to predict how large groups of individuals will behave in certain scenarios.
Furthermore, new participants are constantly entering the market, and they are typically unaware of how the market has acted in the past. As a result, each new generation of market participants frequently repeats the same errors and behavioral patterns. These errors and trends lead to judgments that are either supply or demand for something, which decides the price.
Technical analysis is more about studying mass psychology than it is about trading. We look at how individuals respond in different market scenarios. We can observe pricing patterns and predict what is most likely to occur. Furthermore, the beauty of technical analysis is that it works equally well in markets all over the world, owing to the fact that human nature is universal.
Photo by Ibrahim Boran on Unsplash
Technical and fundamental research aren’t mutually incompatible investing techniques. In fact, they work well together. Although no one investing approach can outperform in every market scenario, if you’re a fundamental investor, adding some easy technical tools to your toolbox can help you beat the market when outperformance is difficult to come by. When the market’s floor falls out, technicals can also assist you reduce your exposure.
Although technical analysis isn’t flawless, it can help us discover high-probability trading opportunities.
Technical analysis may be a very useful tool for analyzing markets, but it’s also vital to remember that fundamentals play a part in the bigger picture.
Many investors, in fact, use a combination of fundamental and technical research to make better investing selections.
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