What is Technical Analysis?
Technical analysis refers to widely applied discipline for forecasting the direction of prices through the study of past market data, primarily price, volume or other underlying measurable market information (market sentiment, insider information, put/call ratios etc.) plotted on charts called technical market indicators. The main purpose of the technical indicators is to analyze the current market or a stock condition!
Definition of Technical Market Indicators
A technical indicator is a result of simple to complex mathematical calculations based on indications of price (e.g. open price, high price, low price or close price), volume (up-volume, down-volume or general market volume etc. ) other underlying measurable market information such as investor’s sentiment, short interest or option data (put/call ratios etc). The result of the calculations is a series of data points shown on charts. This is called a technical market indicator. By calculating the technical market indicator on a regular basis a time series is being created and comparison between the market and technical indicator can be made, especially present and past movements as technical analysts believe that market history tends to repeat itself.
Benefits of Using Technical Market Indicators
Indicators have three main functions: to indicate, to attest and to predict
- Technical indicators are designed to highlight/indicate a specific predefined situation as they analyze the price action of an underlying security closely. If an indicator is flashing a signal, the movement of the underlying security matches the criteria, defined by that specific indicator.
- Technical indicators can be used to confirm a certain situation of the underlying security or to attest other indicators. For example, if a market reaches a new high, it should be confirmed by market breadth or strong volume.
- As history tends to repeat itself, comparison between the market and a technical indicator can be used to predict future price movements.
Complicacy of Using Technical Market Indicators
There is always a trade-off between sensitivity and consistency. If the sensitivity of an indicator is being increased by reducing the analyzing period (for example 5 days moving average instead of a 20 days moving average), the indicator will provide early signals but the number of false signals will be increased.
The longer the time period or the frequency of the input data (daily instead of weekly data), the slower the indicator will react but the signals will be reduced. So the most important thing is to identify which kind of trader (day trader till long term investor) you are and then you will know what kind of indicators you should use.