Traders use technical analysis techniques to help them more effectively determine the best time to enter into a new trade and/or to exit an existing position by identifying price trends and price targets, based on historical price movements.
Unlike fundamental analysts, technical analysts are not necessarily concerned with the intrinsic value of a company. In essence, a technical analyst believes that all good and bad “news” regarding a given company or asset are already reflected in the stock’s current price. They are focused instead on evaluating price and volume action to help them gauge the current momentum and trend and are hoping to determine where and when present conditions might change.
Technical forecasts are based primarily on price and volume data, as well as the use of various chart tools or patterns, indicators, and studies. This information is then used to assess the strength of the current trend, the likely direction of future trends and to generate potential buy or sell signals.
Technical analysis and decision making
Trading involves making many decisions, including what to trade and when to buy and sell. In order to make these decisions, a trader has to form an opinion about where he or she thinks the price of a given stock or asset is going, and how soon it might get there. Traders use analysis as one method to help them identify potential trading opportunities based on external data, rather than relying “gut feel”.
Traders use technical analysis:
- To help identify and/or confirm buy and sell signals – Traders do this by using indicators, tools, and patterns to visually see potential buy/sell signals.
- As a source of confirmation – Traders often gather information from multiple indicators which can potentially signal a higher probability that the trade signals are may be valid.
Shorter-term traders are more likely to use technical analysis than many longer-term investors, since traders are often in and out of a position before any notable changes in fundamental data have time to play out. Investors can, however, still use technical analysis to help locate and confirm potential trading opportunities that have also met their fundamental criteria. While these two approaches are based on different assumptions and inputs, fundamental and technical analysis techniques can certainly be used in a complementary fashion.
Technical analysis has many disciples, as well as many critics. Like any other type of market analysis, it offers no guarantees, but it can be a helpful tool in qualifying stocks and indices that meet specific objective criteria. While people use more subjective reasons for making buy and sell decisions, assessing technical analysis tools can help a trader to develop a more objective method for identifying timely trade entries and exits. While many traders will initially focus much of their attention on timing trade entries, one of the greatest potential benefits associated with technical analysis are in helping traders to determine the best time to get out of an existing position, whether locking in a profit or cutting a loss.
The critical piece of any kind of analysis is to help make a complicated decision easier, even if it doesn’t turn out as planned. Having a clear set of guidelines, however imperfect, is preferable to trading decisions based on emotion. Many traders get caught focusing on the waves and swells of the market, rather than the underlying tide. Technical analysis can serve as a compass, anchor, and rudder to help you better navigate your trading decisions. It’s important to remember that technical analysis should be used in service to your long term goals and not the other way around.