Chapter 3 - Introduction to charts
What is Technical Analysis?
The primary task of traders in the financial markets is to determine the direction of the market and follow it, and this task is done through analysing the markets through one of two methods, either fundamental analysis or technical analysis.
Without going into many details, the difference between the fundamental analysis method in understanding markets and the technical analysis method in determining market trends can be summed up, in that the fundamental analysis depends on studying the factors affecting the supply and demand rule while the role of technical analysis lies in studying the psychological impact of the change occurring to the prices.
Usually, you will find that there is a state of permanent differentiation between the followers of each method, and there are always allegations that the fundamental analysis is better than technical analysis, and sometimes the opposite, that is, the method of technical analysis is superior to the fundamental analysis.
However, we believe that whoever looks at each of the two methods with a differential view is a person whose knowledge has not reached maturity yet, so he was not able to see things completely, and we also believe that both the fundamental and technical analysis complement each other, but the integration there between requires a high degree of knowledge.
We can prove that by just stating that the scientific material of the strongest academic degree specialized in investment and fundamental analysis, which is called the CFA, includes an extensive study of the basics of technical analysis. Similarly, the educational programs of the professional study of technical analysis science through the International Federation of Technical Analysts or any of the affiliated scientific societies involve the study of economics and statistics to develop the understanding of the technical analyst regarding what is happening in the financial markets, and this space is constantly increasing.
Therefore, you will always find that the fundamental analyst has good knowledge of technical analysis, and the technical analyst has a passing knowledge of fundamental analysis, and despite what distinguishes technical analysis in financial markets, we can never lose sight of the feature of full specialization in specific markets for the fundamental analysts.
We'll start talking about technical analysis in more detail.
We first begin with the definition of technical analysis and the basic rules that underlie the science of technical analysis, which represent the philosophy underlying all the tools of technical analysis..
Technical analysis: is the study of market movement, mainly through the use of charts, in order to predict future price trends.
Technical analysis can be also defined as “market psychology study,” which is a more in depth definition of technical analysis.
The Foundations of the Science of Technical Analysis
The science of technical analysis is mainly based on three main rules that represent the essence of this science, and despite the simplicity of these rules, their full recognition represents the cornerstone in the use of technical analysis tools masterfully.
- Market movement settles everything.
- Markets move in trends.
- History repeats itself.
We'll look into these rules in a little more detail, to show the reader a glimpse of the philosophy behind these rules.
1 - Market movement settles everything.
Technical analyst believes that anything that can influence the price, is actually reflected on the market price, whether that thing relates to the fundamental analysis, political or psychological events, or otherwise. Therefore, all that is required is to study the price movement.
The technical analyst also believes that the price movement is only a reflection of the changes in supply and demand.
2- Markets move in trends.
The concept of trend is essential in the technical analysis method. If one cannot accept the idea that the markets are moving in a real direction, then there will be no benefit in predicting future price movements.
3 - History repeats itself.
Human psychology will not change, so the key to understanding the future lies in studying the past.
The Most Important Characteristics of Technical Analysis
- The principles of technical analysis can be applied to all financial markets.
- The principles of technical analysis can be applied to any time frame.
- The study of technical analysis does not require a background in economics, accounting or statistics.
- Economic forecasting.
These features are what make technical analysis always the first choice for newcomers to financial markets, and economic forecasting through technical analysis is considered one of the most superior stages of understanding technical analysis and its dimensions.
- Identifying entry and exit points.
- Using technical analysis tools in making trading strategies and automated trading programs.
These two features specifically lead some to believe that they do not need more knowledge outside the context of technical analysis, and that the development of their results in trading is linked to the development of their skills in the use of technical analysis tools.
Technical or Graphical Analyst?
Charts represent raw material from market data, which can be formed and read in different ways according to the perspective used in its study, so here, we want to clearly define that the tasks of the technical analyst is to study the psychology of traders inside the financial markets, i.e., the technical analyst studies the state of the market, and not just numbers
The graph analyzer (statistical or quantitative analyst) deals with signals and works on measuring, testing and improving them for the purpose of developing automated trading systems. Systems or trading models are programmed into indicators that generate automated buying and selling signals. The purpose is to reduce or eliminate the human element in the trading process.
Therefore, it is important to realize that the graph analysis is only one aspect in the broad base of technical analysis.
Professionalism means more accuracy
Some consider that the science of technical analysis definition and in-depth understanding of the philosophy of technical analysis is a theoretical framework for the study of the technical analysis tools, which leads many to skip this aspect and start quickly to study technical analysis tools that apply to prices. However, we strongly believe that this view is limited to a great extent, since at some point, understanding the philosophy of analysis becomes crucial in understanding markets through technical analysis, especially markets where price charts are more sophisticated and rich in detail.
On the other hand, each technical tool has an underlying psychological dimension, which is the reason for the repetition of the same results when the same situations are repeated, and understanding the psychology of technical tools is the only solution to break the idea claiming that technical analysis tools are just random lines, or that they are tools without an objective basis.
Perhaps we quote a famous saying by the writer, John Murphy, in which he says, "I believe in the power of the idea that a full appreciation of the importance of technical analysis begins with a clear understanding of the things that technical analysis can do, and more importantly, it is the understanding of the philosophy on which these things depend."
This sentence carries a deep understanding of technical analysis and its dimensions. Usually and despite the great importance of the aspect of understanding the psychology underlying the tools of technical analysis, and the philosophy of this science, for those who want to professionalize the use of technical analysis, these two aspects are completely overlooked when explaining the technical analysis tools, most of the time, which impairs the technical analyst's ability to estimate some price positions.