One of the key skills that is applicable for many investments is the ability to read and analyze price charts. This is known as technical analysis. There are people who say that technical analysis is a bunch of hogwash and there is no logical basis behind the patterns and trends spotted. That all price movement is due to news and speculation. That it is open to price manipulation. That it is a self fulfilling prophecy. To me, it is all those things, and a lot more. The key thing to understand about technical analysis is that all impacts on the price of an investment are reflected in the price. All trades taken by anybody, for whatever reason, be it an attempt to manipulate the price, to get into an investment, to exit and investment, to hedge, etc. will have their impact on the price of the investment.
When you are looking at a price chart, you are looking at the outcome of a million different decisions, made by a million different people from across the planet. It is like reading the seismic waves to determine the strength of an earth quake and what exactly is going on in the earth's crust. You can never visit the site of the earth quake, which is usually several kilometers below the surface, but you can get an idea of what is going on by analyzing the outcome of the earthquake, which are the seismic waves. Similarly, you can never determine why the price moved the way it did, unless there is some high impact news broadcast just before a large price movement, but you can try to analyze what is going on by looking at the outcome of all the trading, which are the price movements.
When you are looking at a price chart, you are looking at the outcome of a million different decisions, made by a million different people from across the planet. It is like reading the seismic waves to determine the strength of an earth quake and what exactly is going on in the earth's crust. You can never visit the site of the earth quake, which is usually several kilometers below the surface, but you can get an idea of what is going on by analyzing the outcome of the earthquake, which are the seismic waves. Similarly, you can never determine why the price moved the way it did, unless there is some high impact news broadcast just before a large price movement, but you can try to analyze what is going on by looking at the outcome of all the trading, which are the price movements.
2 branches
There are 2 main types of technical analysis. The first type makes use of tools called indicators and is the more traditional of the two. Indicators are basically mathematical calculations of certain characteristics of the prices. For example, the indicator Average True Range (ATR) simply calculates the difference between the highest price and the lowest price in that period. I personally do not use indicators in my trading as one of the key problems with indicators is that people tend to tie conclusions to what they see displayed by the indicator. One of the first things you learn when you study data science is that correlation does not equal causation. Even though the calculations are showing as such, we do not know WHY those numbers are like that.
The second type of technical analysis is called price action analysis. This arm of technical analysis focuses purely on looking at the price movement, without any indicators. I find this type of technical analysis to be more accurate, as there is no way of hiding what a trader wants to do, as every time a trader makes a trade, it is reflected in the price. By looking at pure price action, you can sense the underlying motivations of the market for that investment product.
The second type of technical analysis is called price action analysis. This arm of technical analysis focuses purely on looking at the price movement, without any indicators. I find this type of technical analysis to be more accurate, as there is no way of hiding what a trader wants to do, as every time a trader makes a trade, it is reflected in the price. By looking at pure price action, you can sense the underlying motivations of the market for that investment product.
2 objectives
There are 2 main objectives when performing technical analysis, to identify the direction of the price and to identify where the price will stop. If you can do either one of these reliably, you can quickly make a lot of money. Over the next few articles, I will try to explain how to perform these using price action analysis. Stay tuned!