What Is Technical Analysis?

The goals of speculators are to identify and execute winning trades. To accomplish this, traders generally employ two very different schools of market analysis to forecast price direction and to formulate trading strategy: fundamental analysis and technical analysis.

Fundamental analysis, the study of the underlying supply and demand factors that cause prices to move, is familiar to most traders. Fundamental analysts track, study and analyze factors such as production and consumption data, economic developments, and government policy in order to forecast the direction of any
given market.

Technical analysis is less familiar but no less effective for analyzing and forecasting market behavior. It is the study of price movement itself, regardless of the underlying fundamental factors that may cause prices to move.

Technical analysis offers several advantages over fundamental analysis, including the following:
• It does not require the specialized, in-depth knowledge necessary for the fundamental analysis of each different market. Instead, the same technical methods can be used over a wide range of very diverse markets.
• Due to its quantitative nature, technical analysis is in many ways less subjective and generally easier to comprehend and utilize than fundamental analysis. Highly specific trading rules can be created and applied directly to the markets. Because of this, analysts/traders can use technical methods to build mechanical trading systems that can help overcome a number of common trading pitfalls such as inconsistency, lack of discipline, and allowing emotion to affect trading decisions.
• Finally, technical analysis has something for every trading "personality"; there are methods suitable for counter-trend day traders as well as long-term trend followers and just about anything in between.

Why Technical Analysis?

Fundamental supply/demand factors form the basis of most long-term and many short-term price moves in commodity markets. But technical analysis can be just as effective as fundamental analysis in forecasting price movement, and in many ways is easier to master and use than fundamental analysis. Why is this the case?
 

Fundamental Analysis
 

Each market has its own set of supply/demand factors plus other unique circumstances that fundamental traders must become familiar with in order to forecast price movement. A fundamental trader wishing to deal with two very different markets would need to learn two unrelated sets of supply/demand factors, which
means scrutinizing a large volume of news and information.
• For example, currency fundamentals involve such factors as interest rate differentials and the economic prospects and monetary policies of different countries. That represents just the tip of the information iceberg for two markets. In addition to the large volume of fundamental information available, the information itself is often vague or its importance may not be readily apparent. Due to the potential for
information overload, fundamental traders often specialize in a narrow range of related markets such as Euro, Japanese yen, and British pound. If they trade other markets they often rely on technical analysis.
 

Why Technical Analysis

• Technical analysis primarily requires price data, which is readily available and inexpensive to get. Analysts/traders can apply the same technical methods, be they price patterns on bar charts or moving average trend indicators, to any market, anywhere, any time. It is not difficult to organize price data, and it is fairly simple to calculate or construct most indicators. Personal computers loaded with easy-to-use
FX trading software packages can now generate, in a matter of seconds, the mathematical formulas required for most technical indicators.
• Technical analysis has wide appeal because analysts/traders can forecast markets and make trading decisions quickly by looking at a chart or technical indicator. While it’s true that a single fundamental development (i.e., economic number reports) can crystallize trading opinion and trigger a major price move, most fundamental decisions are grounded in complex, time-consuming supply/demand or economic analyses. Although any given price is arguably the culmination of all the known fundamental factors, technical indicators can often give the first sign of a change in the fundamental situation or a change in trader perceptions, even though that might not be readily apparent from the fundamental news itself.
• Technical analysis is appealing due to its quantitative properties. Price data is easy to manipulate and the technical indicators themselves can be changed and tailored for different market conditions. Also, technical analysis is perceived as less subjective than fundamental analysis. It's often difficult to gauge the importance of fundamental news and how it should affect prices. On the other hand, technical signals tend to be less ambiguous.