What Is Technical Analysis?

Technical analysis is the study of past market movements as displayed on price charts to predict future movements of share prices. When defined like that it does sound like a lot of nonsense but in actual fact technical analysis can be extremely accurate at predicting future price moves and many traders and investors, including myself, swear by it.

Technical analysis is used extensively amongst forex traders but it can be equally as profitable when used to predict the movements of stocks. Of course if you're a long term investor then you should also use fundamental analysis to select quality companies with low levels of debt and growing profits, but when you've done this you can then apply technical analysis to determine profitable entry and exit points.

So what are the basics of technical analysis?

Well first of all if you have access to stock charts, you will also usually be presented with a number of studies that you can apply to this chart. These technical indicators, of which there are many, can be used to identify current trends, indicate oversold and overbought positions, and show any breakouts that are taking place.

They work because they basically display human behaviour via a chart. They show the same sorts of trading patterns which occur over and over again because other traders see these same patterns and trade them accordingly. You could say that to a large extent technical analysis is a self-fulfilling prophecy because if enough people apply technical analysis to a particular company's price chart then the predicted move as indicated by the charts will eventually come true if enough investors make trading decisions based on the same technical data.

The most popular technical indicators are moving averages, MACD, RSI and Stochastics, but there are a number of other indicators you can use. It's best to try out different combinations of indicators to find ones that perfectly compliment your trading system. No technical indicators are perfect, whether they are used in isolation or combined with others, but the key is to use them to find trades where the odds of the trade generating a profit is significantly in your favour. 

So to sum up, technical analysis is a great way of entering and exiting trades whether you are a short-term or long-term investor. It works on all time frames but is more effective when used on the longer time frames. The right combination of technical indicators can enable you to find high probability trades which can produce big profits if you cut your losses early and let your winning trades run.