Technical Analysis of Stocks - part 2

Technical analysis is based on principle that history repeats itself. Behind this principle is human psychology. Charts reflect psychology of the market. Chart patterns have been studied and categorized over one hundred years. Some of these patterns have worked well in the past, so it is assumed that they will continue to work well in the future. These are based on study of human psychology, which tends not to change.

Next very important premise of technical analysis is that everything what can influence the price like fundamental, psychological, political, or other factor is actually reflected in the price of that market. And how is the price created? From technical point of view price movements reflect relation between supply and demand. If demand exceeds supply, price should rise. If supply exceeds demand, price should fall. This is basic economic principle. Behind demand are buyers and behind supply are sellers. Behavior of buyers and sellers is what drives the market. These willing buyers and sellers come to an agreement of price but are in disagreement as to value.

From all this results that analyzing price and it's history is indirect analyzing of fundamental and other factors that influence market behavior. Although this argument is quite controversial, most of technicians would agree. The question of this post is - what is all this analyzing for? The purpose of studying price charts and supporting technical indicators is to show trader which way is the market most likely to go. This last sentence is very important and notice that technical analysis is not for predicting future actions as a sure thing. Technical analysis uses term probability. When graphical picture of change of price in chart is in some pattern there is some probability that price will go in certain direction. This claim is based on research and analyzing price movements in the past.

Oftentimes happens that some traders who are new to technical analysis are little disappointed when some of their trades doesn't go well even though according to the chart analysis it should. Well, it's not magic. And it doesn't have to be. Technical analysis helps many traders and institutional investors to make very profitable trades, so it doesn't have to prove it's value.

One of the main objectives of chart analysis is to determine the trend of prices. The key concept and discovery in technical analysis is that prices move in trends. A trend represents a consistent change in prices in some direction. The most of trading techniques are based on determining trends and trading in the direction of those trends.

One of the most interesting facts about technical analysis is it's adaptability. First is the adaptability to different time dimensions. Chart analysis is used in day trading and also in longer term investing. Next is the adaptability to various trading mediums. Charts are analyzed in trading with stocks, commodities, foreign currencies, and so on. This is because the same principles are so widely applicable. This is a big advantage against fundamental analysis where traders are more specialized.

The bottom line is that the same data like open, high, low, and closing price are available to all traders, but how they analyze, interpret, and act on the information available is one from factors that differentiate one trader from others.