Technical Analysis: Chart Study System for Trading Strategies

Technical analysis is a primary trading tool that helps participants understand market movements. This method is based on the assumption that all publicly available information is already reflected in the asset’s price. By analyzing price changes and their volume, traders can identify market trends and forecast future price movements. Both professional and non-professional participants use technical analysis to identify optimal times for trading operations.

From the 17th Century to Today: The Evolution of Technical Analysis

Chart analysis is not a new phenomenon. The earliest forms of technical analysis appeared in Amsterdam in the 17th century and later spread to Japan in the 18th century. However, the modern system of technical analysis was largely shaped by Charles Dow, a journalist and founder of The Wall Street Journal, who observed that financial markets tend to move according to recognizable trends.

Dow’s work laid the theoretical foundation known as Dow Theory, which fundamentally transformed technical analysis and helped establish it as a systematic discipline. In the modern era, with computer technology enabling complex calculations, technical analysis has become an indispensable tool for thousands of investors and traders worldwide.

How Market Forces Shape Price Movements

The price of an asset reflects fundamental market dynamics: the balance between buying and selling forces. These forces are closely linked to participant emotions—fear and greed. When the market is concerned about negative signals, sellers dominate; however, when optimism and confidence prevail, buyers take control.

It is important to understand that technical analysis is most reliable in markets characterized by high volume and liquidity. Highly liquid markets reduce the risk of price manipulation and external shocks. Conversely, low liquidity or highly volatile periods often generate false signals and misleading information.

Key Technical Analysis Tools

Traders use the following main systems as aids:

Moving Averages: Identifying Trends

A moving average shows the average price over a specified period. The simple moving average (SMA) considers all price points equally, while the exponential moving average (EMA) gives more weight to recent data. Many traders interpret the crossover of two different period moving averages as a signal of changing market conditions.

Relative Strength Index: Identifying Overbought and Oversold Conditions

The RSI indicator measures the speed of price movements, oscillating between 0 and 100. When RSI exceeds 70, it often indicates overbought conditions, which may lead to a price correction. Conversely, when RSI drops below 30, it signals oversold conditions, often presenting a buying opportunity.

Bollinger Bands: Measuring Volatility

This indicator consists of a middle band (a moving average) and two outer bands that vary according to market volatility. When the price approaches the outer band, it may revert to the mean, making this instrument useful for identifying potential scenarios.

MACD: Trend and Momentum Analysis

The Moving Average Convergence Divergence (MACD) is a more complex tool that compares two moving averages. When the MACD line crosses above the signal line, it generally indicates upward momentum. When it crosses below, it suggests potential decline.

Trading Signals: Practical Application

Indicators not only show general trends but also generate specific action signals:

Moving Average Crossovers create two main signals. When the fast (short-term) moving average crosses the slow (long-term) from below (golden cross), it is often seen as a buy signal. When the crossover occurs from above (death cross), it indicates a potential sell.

RSI signals help identify extreme conditions. If the RSI hits 70, it suggests overbought conditions, which may lead to selling pressure. Conversely, an RSI below 30 indicates oversold conditions, often signaling a buying opportunity.

MACD signals occur when the MACD line crosses the signal line. A crossover from below indicates upward potential, while a crossover from above suggests downward risk.

It is important to note that these signals are not perfect. Technical indicators often generate “noise”—false signals—especially in short-term trading. Therefore, it is essential to use multiple methods and implement proper risk management strategies.

Limitations and Criticism of Technical Analysis

Many academics and experienced market participants oppose technical analysis, claiming it is a “self-fulfilling prophecy.” The idea is that the method works mainly because many people believe in it and act accordingly.

Subjectivity is a significant issue. Two analysts looking at the same chart can draw completely different conclusions. The patterns and templates seen in charts are not objective facts but interpretations that depend on the analyst’s mindset.

Market anomalies are especially evident during crises or unexpected events. When markets experience shocks or political decisions, price movements can completely defy the statistical models used in technical analysis.

Despite these criticisms, many professional traders value technical analysis because each analyst has their own way of interpreting charts. This means it is not accurate to say that all traders use the same strategies.

Technical Analysis vs. Fundamental Analysis: Which to Choose?

Fundamental analysis and technical analysis are two different philosophies. Fundamental analysis examines the intrinsic value of an asset, relying on financial statements, economic indicators, and qualitative factors. Technical analysis focuses solely on historical price data and patterns.

Time perspectives differ: Technical analysis is suitable for short-term trading strategies, where precise entry and exit points are crucial. Fundamental analysis is better suited for long-term investment decisions, as it assesses the overall potential of the asset.

A practical combination is the optimal approach. Many professionals use a blend of both methods: fundamental analysis helps decide what to buy, while technical analysis guides when to buy.

Final Remarks

Despite its criticisms, technical analysis remains a significant tool for market participants. It provides valuable insights into short-term market movements and can help traders make more informed decisions. However, to maximize its benefits, it should be used alongside fundamental analysis, solid risk management principles, and an understanding of market limitations.

It is important to remember that neither technical analysis nor any other method can guarantee profits. Every participant should carefully assess their risk tolerance and use technical analysis as a tool to make better-informed decisions, not as a guaranteed source of profit from the market.