No matter the kind of vehicle you choose for your actions, there are some basics that you have to be familiar with. This fundamental knowledge is mostly connected to the behavior of the markets. If you learn how to recognize the way they behave, you will be able to anticipate the movement of the prices more accurately, thus make smarter decisions while trading. It can be interesting to note that regardless of the value that is traded on the market, some concepts can always apply to the prices and their way of performance on the market.
This can be explained by independent traders and investors being responsible for short-term price fluctuations. We can say that the price depends on the actions of the people who invest or trade values on the market and that prices react in a similar way when they are given similar input or stimuli. The study that is dedicated to researching the ways of price behavior is called technical analysis and understanding its basic is one of the most essential education points that you will need to be able to make correct financial decisions on the market.
The Basics Of Technical Analysis
Technical analysis represents a huge topic. If you decide to enter the market and become an investor, there is a high possibility that you will catch yourself coming back to studying and learning something new many times for as long as you intend to work as a trader. That is why every person knowledgeable in options trading would advise that a basic understanding of technical analysis is a very important step for every person involved in the market. However, you don’t need to know everything about it right away. Since it is a large area of research, it is ok if for some aspects of your business you just research parts of the technical analysis that you are particularly interested in for that concrete project. For instance, the technical analysis offers more than a hundred indicators for analyzing the market. In reality, traders usually use three or four, mostly the most popular ones or just those that they were familiar within the first place.
If you don’t limit yourself only to option trading but you do trade in general, you will realize that technical analysis can be applied to any financial instruments such as futures or stocks for example.
We can say that their basis is in psychology and human nature in general and how they behave in practice. For better understanding, we will overview some of the main topics in technical analysis. These topics will be:
Technical analysis’ foundation; how to chart principles and trends; patterns in technical analysis; technical analysis through the movement of the averages, and Indicators in technical analysis.
Technical Analysis’ Foundation
The main basis of the technical analysis is found in the term known as ‘’ market action’’. Market action represents a whole personal knowledge about the trading market, and it doesn’t include information that you might obtain from an insider. It can be simply defined as a study that determines: ‘’the way that the price moves over time’’. If possible, it also examines its volumes and how they change over time too.
Still, the fundamental concept of technical analysis is based on the premise that the behavior of the market is a reflection of everything that happened and will happen with the price at a certain moment. Many things can have an impact on the price, and the amount of the impact depends on the market in which the trade is made. That’s where technical analysis comes in, it cuts across all of those possibilities. It states that all the things that can be known about the price are already included in the price that we see at the moment we want to trade.
This means that you shouldn’t worry too much about the things that influence the price, as according to this it is enough to follow how the price changes over time and you will get all your answers. At first, many people wondered if this kind of principle can work because it sounded rather easy. If you had any doubts, the answer was already proven and it says that yes, technical analysis is successful although this kind of definition doesn’t seem that complicated.
However, there is one very important point coming out from all of this. Technical analysis doesn’t guarantee the behavior of the price. It can tell you that the price will increase or decrease for a certain period, but that doesn’t necessarily happen. It may or it may not. The reason for this is that regardless of the calculation that the market has to do something, it is impossible to be 100 percent sure that it will. The market has its own ways and eventually does what it wants. So, what technical analysis does is that it gives you the indication that shows what will be the most probable outcome, which means that the only certainty that you get is to know if the law of probability is on your side or not.
You can do a large number of average trades and hopefully make some profit, but you should never invest an amount of money or some valuable goods such as your house or your car if you can’t afford to lose it. It is not recommended especially if one successful trade makes you confident that just one is enough to be a good technical indicator for certain gain. This is one of the reasons why the first task of technical analysis is to improve your chance for success by analyzing the prices and the way they behave on the market.
The second reason for the analysis is the fact that prices almost always change using certain trends. For instance, if the price increases its trend will be to rise until there is something that disables it from further growth. In comparison, we can say that prices act like Newton’s motion law, which says that: ‘’a body in motion will stay in motion unless acted upon by an external force.’’ Of course, to prove this to be true, it has to happen over time. If this weren’t the case the price charts represented in many analyses wouldn’t be the way they are. They would be illustrated as a random movement of the prices. The third reason is that technical analysis supposes that history will, as always, repeat itself. If certain situations happened in the past, and you see them happening once again in the present than it is highly expected that the same thing will happen in the future too. Since people are not expected to change in this equation, the second logical conclusion would be that their results will be the same too. In a nutshell- this was a very foundation of technical analysis. Don’t forget that one of the most efficient ways to become good in trading and to increase your chance to become a successful investor is to be able to use most of the things that this analysis can give you.
There are a few arguments that you can hear against the use of technical analysis. Still, the only proof that you really need is the fact that this analysis works and that at least it can improve your chances to get more percentages while trading. However, we will point out some of the attitudes toward technical analysis:
One of the traders said: ‘’Charts only show what has happened in the past, how they can reveal what hasn’t happened yet?’’ The answer to this is quite simple, there is evidence from earlier trades and those pieces of evidence are used in technical analysis with the premise that history will repeat itself. This way you can anticipate at least with some fair certainty what is the next thing that will happen with the price on the market. In comparison, it works in a similar way as the weather forecast, if they say that it will rain on the TV, you know that it might not rain even though they said it will, but you take your umbrella with you anyway. The same principle applies with the technical analysis and that is how you can predict the future by using the past events.
Another trader noted: ‘’If the prices already incorporate everything there is to know, then any change in price can only come from new information that we don’t know yet.’’ This kind of idea doesn’t only appear in trading options, it is present in all financial markets. It surfaces in many areas and even academics are still discussing it. Differently, from the opinion that is popular between the traders, this concept doesn’t actually say that the price that is currently on the market is the correct one. It just states that it isn’t possible to establish if that current price is too low or too high. That is why the smartest choice to deal with this concept is to prove in which way technical analysis really works. In the end, if everyone supported this kind of idea then we would have zero analysis and the price would be always the same. We can imply that technical analysis has self-fulfilling characteristics. This means that if the majority of traders do the analysis and estimate that the price has to increase all of them would become buyers on the market, which would mean an increase in demand, thus price that went up. The same principle applies to the price that is supposed to go down. This is one more example in which technical analysis showed that it works. Of course, there can always be some doubts, but does it really matter to prove why the price went in the direction that you thought it would? Additionally, if a large number of traders who are not well educated and they just want to make quick profit fail, it can be seen as a sort of evidence that the idea of having a massive number of traders regardless of their knowledge and dedication is somehow wrong from the beginning.