Questions like which method to use to trade often fill the minds of many investors. Technical analysis, for instance, allows you to assess investments and highlight trading possibilities by looking at statistical patterns of previous trading activities. This is quite different from the traditional approach of fundamental analysis, which analyses factors like sales and earnings to determine the worth of security.
And, of course, the importance of staying informed in online trading can never be overemphasized. Do you actually know that previous studies have found that nearly 90% of traders lose money just because of such issues? You do not want to be part of this statistic. Here, we will present you with amazing facts to help you enhance your experience.
Why is technical analysis important?
A good number of experts actually agree that markets tend to repeat themselves to a certain degree. Several reasons could explain this, but in part, the collective behaviour of market participants. With technical analysis, you can then have a preview of historical price movements, which can help you make a better decision.
Another good side of this approach is that you can actually apply it to different time frames – whether minutes or years. That makes it suitable for traders of all kinds, whether day traders or long-term investors. And if you keep varying markets, you can maintain the same principles, as technical analysis is not limited to a specific market.
In an era where people value immediacy, who does not want to enjoy real-time charting capabilities? By the way, do you know that, according to Zendesk, up to 72% of customers expect immediate services? This is definitely not an apparent need in commerce only but in forex as well. Real-time analysis allows you to instantly manage trades on an index trading platform, use short-term price movements and quickly detect exit and entry points.
Why would you want to miss out on the beauty of using concrete data as you trade? Navigating the complexities of trading needs more than just an instinct; you must take advantage of data. And this is what technical analysis offers – it allows you to use previous price movements and volumes to make decisions. Plus, the possibility of identifying stop-loss points and risk-reward rations can help manage risks.
What are the general assumptions of technical analysis?
Do you remember someone by the name of Charles Dow? It has now been more than a century since this American financial journalist released some articles highlighting the theory behind technical analysis. His editorial work would later become what we would call the ancestor of modern technical analysis. After he died, Samuel A. Nelson, his dear friend, in his book, ‘The ABC of Stock Speculation,’ tried to explain what Charles had written.
William P. Hamilton, Dow’s successor at the Wall Street Journal, also added to Dow’s contributions, refining and developing them into a theory. Later, Robert Rhea studied the work of both Dow and Hamilton and came up with the book, ‘The Dow Theory of 1932.’
Here are the six principles of this theory.
Everything is discounted by averages
This is so because averages reveal the activities of millions of investors, traders and speculators at any single time. Everything that is known about an individual stock is reflected by its price.
With new information coming to the market, participants will likely disseminate it quickly and cause the price to adjust accordingly.
The market has three trends
This second principle assumes that the market always has three forces in effect:
- The primary or major trend which mostly lasts one year but can extend for several other years. It can cause the price to either move up or down by at least 20%. If this trend becomes overstretched, the secondary trend can interrupt it to correct it.
- The secondary trend which moves in the opposite direction of the major trend. It can be difficult to identify it at times, and it mostly lasts anywhere between three weeks to several months.
- The last trend is the minor trend, which shows the daily fluctuations of averages. Although it lasts for less than six days, Dow Theory doesn’t seem to give it a lot of significance.
There are three phases within primary trends
When the primary trend is advancing, then that is considered a bull market. Here are the phases within this market:
- The accumulation phase, where astute investors are buying at low prices because of bad economic times.
- The steady advances phase comes afterwards and is often marked by increasing activity.
- The phenomenal advances phase happens when many individuals from the market participate.
The bear market happens when the primary trend is declining:
- During the distribution phase, astute investors begin to sell their holdings. The trading activity is still quite high but has started to decrease.
- Buyers continue to thin out, leading to the panic phase, where selling is more urgent.
- The panic phase leads to the final phase, where buyers are highly discouraged from selling.
Each average confirms the other
What this means is that at least two averages must all be moving in a similar direction. If the Industrials and Transports do not confirm each other, then it might not be a 100% valid trend. They must both extend beyond the last secondary peak or trough.
The trend is confirmed by the volume
This theory majorly depends on price action and may use volume only in uncertain situations. For instance, the volume should increase during market advances if the primary trend is up.
A trend does not change unless there is a definite reversal signal
Let’s consider an upward trend, for instance. This will often be characterized by a series of higher highs and higher lows. And to guarantee a lower trend, there must be at least one lower-high or lower-low.
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