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  • by Giovanna Scarpelli
  • Jul 25, 2022
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Technical analysis: Tools and Methods

 

  • What is technical analysis based on?
  • Tools for technical analysis
  • Technical analysis methods
  • Disadvantages of the technical analysis method
  • Advantages of the technical analysis method

 

What is technical analysis based on? 

What is technical analysis based on? Technical analysis is a type of tool that emerged at the end of the 19th century, based on the study of market trends on New York City's Wall Street. This tool's function is to study the financial markets, through data, price patterns, quotes, and future trends. 

However, unlike fundamental analysis, which focuses on the economic, social, and political context, this analysis is purely mathematical and algorithmic, always based on previous patterns and data, giving advantage and a better adaptation to short-term operations.

For example, if we carry out a technical analysis on JPMorgan Chase & Co. we will not take into account the statements of its managers, the press releases, nor even the results or the rumors of a possible crisis. The investor will only focus on what appears on the charts.

Everyone wonders what the function of charts is, and the answer is that they are really useful as they allow the investor, through study and analysis of them, to anticipate possible upward and downward movements of the market.

Technical analysis is what we use to study and predict movements and price changes in the financial markets, not only by means of charts as mentioned above but also through studies and statistics, so that we can identify patterns and be able to make future decisions based on them.

The sources of information when investing in this market through this tool could be generalized:

- Open interest

- The trading price the trading volume

- The price or quotation.

 

Tools for technical analysis

Tools for technical analysisTechnical analysis has different tools to obtain information and probabilities. Such as: 

-       Chartist figures. We can identify them as they are the shapes and silhouettes that are created by the charts describing the price trends of a given asset in a given time. These representations (ascending and descending figures) have different names and analyses.

-       Japanese candlesticks. This is a chart that stands out in the technical analysis of the stock market. In this, we can identify the opening and closing prices of security as well as their maximum and minimum.

-       Technical indicators. Their objective is the prediction of changes in order to detect them and be able to act in advance. They use mathematical and statistical expressions.

  

Technical analysis methods

 Technical analysis methods

-       Establish a breakout percentage. The percentages vary according to the trend lines that are identified.                 

Trend lineWeatherPercentage of breakage
PrincipalMore than 1 yearFrom 3% of the total
SecondaryOf monthsFrom 2% of the total
IntermediateOf daysAs from 1%
IntradayNo commissionsStarting at 0.1%-02%

-       Overcome the last support below the trend line.

If the new candlestick closes above the last support of the trendline, it can be considered broken. To be able to detect it requires skill and experience, or else you can easily mistake it. This allows you to act very quickly when trend changes are detected.

-       Trend breakout without rising volume is not very reliable.

  Since the tendency is that the volume increases quickly because if it does not or tends to decrease we cannot have sufficient reliability of rupture. This criterion usually prevails in cryptocurrency operations.

-       The break with a gap or GAP

Technically the zone is not broken if not overcome with a gap, making it very reliable. We can find them in stock or futures markets, leaving aside forex and cryptocurrencies.

-       The PullBack

 It is when the momentum changes direction by turning around and the chart ends up resting on the trend line. So if the pullback is successful, it indicates a trend turn, entering at the best point to enter it.

-       Exceeding the last relevant high or low

It is the method most applied by pure technical analysts, as it is visual and reliable, but the experience is needed.

To achieve this we point out the decreasing maximums of the downtrend and we join them with a trend line, once we have this we make a horizontal line at the last relevant maximum since it is the area that the price must overcome to be able to affirm that the trend is broken and subsequently obtaining a pullback and a breakout.

 

Advantages and Disadvantages of the Technical Analysis Method

However, in contrast to fundamental research, technical analysis is not particularly useful for determining the true value of a company because it focuses on past prices rather than future projections.

Disadvantages of the technical analysis method

Disadvantages of the technical analysis method

  • The assets we use have to be listed on the stock exchange
  • The analysis of financial statements is superfluous
  • Lack of scientific objectivity
  • The uniqueness of the appearance of a pattern (giving room for inconsistencies in the analysis and unconsciousness in the methods)
  • It often presents liquidity problems in countries where the stock market is not fully developed
  • It does not provide insight into the fundamental analysis underlying the market
  • Asset prices are affected by emotional or cognitive biases, thus individualizing each trader

 

Advantages of the technical analysis method

Advantages of the technical analysis method

 

  • It can be used in any phase of time, from minutes to days
  • It can be used for short-term as well as medium and long-term investments
  • The variant of the analysis is the price and it is the same for everyone so we could consider it more objective
  • All information is reflected in the price
  • Thanks to the technical analysis the investor with little experience can improve his knowledge and technique to be able to achieve better decision-making
  • We can be guided by a great visual aid with graphs that provide the trend of the assets
  • It helps to detect patterns with the use of different techniques