Technical analysis focuses on price movement of a security and uses past data to predict future price. Then technical investors usually begin their analysis with charts while fundamental investors begin with a company’s financial statements or economic factors. In this topic, we will take a deeper look at technical analysis, understand three philosophy premises of technical analysis as well as their applications.
This means that everything affects the market is fully reflected in market price. Then the fundamental, political, psychological, etc is actually reflected in the price. Hence, there is no need to study a company's financial statements. and economic reports. Technical investors believe that price action reflects shifts in supply and demand. If price is going up, demand must exceed supply and the fundamental must be bullish. Inversely. if price is going down, supply must exceed demand and the fundamental must be bearish. Then, technical analysts do not concern with the reasons behind why prices rise and fall. They are worthless since the price already reflects all relevant information.
This is an essential premise of technical analysis. If price does not move in trend, there is no point to study further. The whole purpose of technical analysis is to indetify trend in early stage. Then an investor will follow the trend. In addition, a trend in motion will keep its direction until it reverses. This is an extremely important point. In FX trading, an investor always remember that Do not fight the trend. And do not exit your winning position too soon when you are rising on a right wave because a trend tends to persist until it has a sign to reverse.
This is based on human psychology research. That means human behavior tends not to change. Then technial analysts study chart patterns, which reveal the psychology of the market. These chart patterns such as double tops, double bottoms, head and shoulders, ect worked well in the past. And it is assumed that they will work well in the future. Hence, the future is predictable by studying the past. The below chart is a Head and Shoulders pattern, short selling is recommended when price breaks down the neckline.