Defining Technical Analysis
The study of price and volume fluctuations over time is known as technical analysis. Financial charts are typically used in technical analysis to assist in the understanding of these movements. A technical analyst is any one who examines financial charts. Although technical analysts are surrounded by data, charts, raw numbers, mathematical formulas, and so on, they also study human behavior, particularly how the masses respond to greed and fear. The market for a certain stock is made up of all investors who are interested in it, and the price of that stock is determined by the emotional state of those investors. The stock will climb if more investors believe it will! If more feel that the stock will fall, then it will. Thus, a stock’s price change over time is the most accurate record of the emotional state — fear and greed — of the market for that stock, and thus, technical analysis is, at its core, a study of crowd behavior.
“Weathering” the Market
When was the last time you saw a local weather prediction that was 100% accurate? It’s likely that at least part of the weather forecasts your local meteorologist gives you won’t materialize. The majority of the projections are frequently incorrect. Why, therefore, do we continue to pay attention to weather forecasts?
Forecasts of the weather are useful because they allow us to plan for the future. We take our umbrellas with us when we go outside if it is predicted to rain. We pack our sunglasses in case of forecasted sunshine. Although we are aware that we may not require these items, we prefer to be ready in case we do.
Weather forecasting is a lot like technical analysis. T/A can help you prepare for what is likely to happen, but like with many weather forecasts, things can alter in unexpected ways, as good technical analysts are aware. Technical analysis and weather forecasting are similar in the following further ways:
• To learn more about the factors that lead to weather changes, such as fronts, high pressure, low pressure, and so on, weather forecasters first measure temperature and air pressure. Technical analysts use price and volume to determine more about the factors that cause market changes – i.e., fear and greed, trends, reversals, support, etc.
• Weather forecasters still use their experience and intuition when making each forecast despite having access to a large amount of data. The individual conducting the analysis—you!—also plays a significant role in technical analysis.
• Local expertise and knowledge are required for accurate weather forecasting. A Florida-based forecaster moving to Alaska will need time to get used to the weather there. In a similar vein, technical analysis necessitates knowledge of the various markets being charted—stocks are distinct from commodities, mutual funds from small stocks, large stocks from small stocks, etc.
• In the beginning of weather forecasting, con artists attempted to persuade people that they had complete control over the weather or that their predictions were always correct. Unfortunately, similar assertions regarding technical analysis are still being made today.
· Weather forecasts tend to be most accurate when things aren’t changing. If it has been sunny for the past three days and no big weather systems are approaching, chances are it will be sunny again today. When conditions aren’t drastically shifting, technical analysis also works well. Both disciplines have more trouble with predicting exactly when big changes will occur.
• The “mid-sized view” works well for both technical analysis and weather forecasting. While predicting the weather for a large city is possible, predicting things for a city block is very hard. Similarly, second-by-second technical analysis can be extremely tricky; daily and weekly analysis is more reliable.
In contrast, predicting the market as a whole (e.g., “This year stocks will go up”) and the weather for the nation as a whole (e.g., “It will be sunny in the US today”) are too broad to be useful.It is easy to lose perspective on what technical analysis can and cannot do. Remember this comparison with weather forecasting to keep yourself aware of its benefits and limitations.
