Technical analysis

Technical analysis is a type of stock analysis that studies the movements of prices through charts and indicators based on asset prices.

In simpler terms, a publicly traded asset (for example, a stock) moves in different directions. Sometimes it goes up, other times it goes down and other times it doesn't move. What technical analysis does is analyze those movements up, down or lateral movement, to try to predict what the future movement will be. Of course, to analyze these movements he uses various tools, which we will see later.

Origin of technical analysis

The analysis of price behavior has been studied for centuries. Some aspects similar to the current technical analysis began to appear in the seventeenth century with the Spanish José Penso de la Vega in his financial analysis.

One of the economists who most evolved price analysis was the Japanese Homma Munesiha, who developed Japanese candles in the 18th century. He was a merchant in the rice market. To get more information on the price movement, he began to analyze the charts deeply and thus try to predict their behavior.

However, according to many experts, technical analysis was born with Charles Henry Dow towards the end of the 19th century. Charles H. Dow was the creator of the Dow Jones Index and the theory that bears his last name: The Dow Theory. Which is based on some simple rules about how stock assets move. Such was the success of his theory that even today many operators and analysts apply it frequently.

Principles of technical analysis

Before looking at the different types of tools that technical analysis draws on, it is important to see what their principles are. That is, what are the pillars on which its validity is sustained. In other words, what is the technical analysis based on to support its predictions? This question was answered by Charles Dow when he created his theory and summarized it in three principles:

• The price discounts everything

It is the most important principle of technical analysis. According to technical analysts, all the information is included in the price. That is to say, political factors, wars, reports of profits of a company, social situation of a country. Everything is discounted in the quote. See market efficiency

That said, the technical analysis does not say that many factors do not affect the stock market, but that everything that affects it will be reflected in the price. If there is a war, the price will move in one direction, if there is a very good or very bad earnings report, the price will move in another direction. Let's say that technical analysis is based on supply and demand. The price is sovereign.

• Markets move in trends

The stock market moves in trends. This is something that happens without exception. Of course, let's not forget that a trend can be bullish or bearish, but also lateral. With which, the price of an asset will move up, down or sideways.

According to Dow, an asset is trending until proven otherwise. That is, until the reference maximum or minimum is not exceeded, the trend continues. See Dow theory

• Human behavior repeats

It is well known that people always behave in the same way or, at least, in a similar way in similar situations. Throughout the history of humanity, greed, overconfidence or panic are feelings that have stood out over others. Not only in stock market terms, but also in other fields.

Technical analysis, under the precept that human behavior is repeated, states that unconsciously patterns are created in prices that reflect this behavior. Thanks to this, its study allows to predict future price movements. See trading psychology

Technical analysis tools

Technical analysis is made up of different tools. New tools, new indicators, new patterns, and even some types of analysis that fit into technical analysis are included each year. However, we can differentiate, in general, three well differentiated types of tools. Differentiated but all be said, not incompatible, and even complementary in some cases.

Chartist analysis includes major chart figures, Japanese candlestick patterns, and Elliott wave theory. In general it is the study of graphics and their formations. For example, a double bottom, a flat pattern, or a head shoulder shoulder.

It is the quantitative analysis through technical indicators. These indicators are representations of mathematical formulas calculated on the price of an asset. There are many types of indicators depending on what they represent. For example, the stock volume, an average RSI, the macd or the bollinger bands.

Criticism of technical analysis

The main criticisms of technical analysis come from the theory of the random walk. The theory of the random walk affirms that the stock prices cannot be predicted, since these are completely random.

On the other hand, it has also received some criticism from those who think that stock movements can be predicted but technical analysis is useless for that. The reason they give is that it is based on past data. And since past returns do not guarantee future returns, it makes no sense, among other things, to carry out technical analysis.

In any case, technical analysis is the most popular analysis on the stock market. It has many followers, analysts and even fund managers who apply it in their operations.