Technical Analysis Explained
Acknowledgements
I wrote this brochure about Technical Analysis during my time at Lloyds TSB Bank plc., Geneva. Many thanks to my former employer giving me the permission to publish this work on Dolefin´s website. I also take the opportunity to express my gratitude to all the authors who provided me with so many valuable ideas about technical analysis that have become indispensable in my daily work at Dolefin.
Introduction
Among the various tools financial analysts utilise for market forecasting, there are basically two methods: fundamental and technical analysis. In this brochure we are pledged to familiarise you with the technical approach. For a market analyst, whether fundamental or technical, there is a basic question: what are the factors which may influence market developments?
Political events like government changes, supranational summits, war, as well as - more specifically - monetary policy certainly have a definite impact on financial asset prices. Other facts are to be considered, however; large "stop-loss" orders or erroneous news caused by unverified rumours can quickly trigger big price moves; evidencing that human behaviour is quite important in interpreting the various investment criteria. Hope, fear, panic and euphoria are among the main parameters in price fluctuations. Whilst fundamentalists essentially rely on economic data, technical analysts tackle the problem in another way. Charts are obviously most useful to track historical evolution; in addition, moreover, they reflect the psychological rationale behind price formation.
Instead of focusing on certain particular indicators and thus run the risk of omitting other important elements, technical analysts endeavour to interpret charts with methods which have now been well established for years and years, most of the time mathematical or geometrical.
Although we are intimately convinced that technical analysis is a valuable forecasting tool, we recommend to handle it with caution: this technique is not an exact science. Even the most professional technical analysis has some room left for unexpected market developments. He doesn't rely on a fixed set of intangible definitions, but depends on the realisation of various conditions. As a result, investors who follow technical analysis must be extremely flexible. If one of the trigger levels - as defined by the original scenario - is reached, the latter must be immediately revised and adapted to the new market situations. Hence we dare say that a rigorous management of "Stop-loss" and "Stop-profit" levels is a must, in the practical use of technical analysis.
"The market action discounts everything". This statement is a valuable summerization of the philosophical aspects concerning technical analysis described in the introduction above. Unless the full significance of this premise is fully understood and accepted, nothing else that follows makes much sense. Whilst insisting on this fact, we illustrate once again the philosophy through the graphic "figure 1".