Understand Why Technical Analysis Works In Trading
Technical analysis is rooted in the belief that human behavior and market psychology play a significant role in asset price movements.
It assumes that historical price and volume data reflect these behaviors, and that patterns and trends can emerge as a result. Traders and investors tend to react to news and events in predictable ways, often creating repetitive chart patterns that technical traders can attempt to identify and profit from.
Thousands of years ago, buyers and sellers of goods felt the same emotions of greed and fear (and everything in between) that that buyers and sellers of asset prices experience today. In other words, humans do not change, therefore chart patterns repeat over and over again.
The widespread use of technical analysis can also contribute to its efficacy. When many traders observe and act upon the same technical signals, their collective actions can create self-fulfilling prophecies, pushing prices in the direction predicted by the analysis.
Institutions create algorithms that spot these patterns as well, exploiting the emotional responses of retail investors while also using the aspect of self-fulfilling prophecies to their advantage.
Technical analysts and traders focus primarily on price and volume data, filtering out other factors like company fundamentals or economic conditions. They look at those factors as noise that can be a distraction.
This simplified approach can be useful for short-term trading decisions and can help identify potential entry and exit points for trades
Technical analysis provides various tools and techniques for risk management, such as stop-loss orders and trailing stops, which can help traders limit their potential losses.
The beauty of technical analysis is that it helps investors and traders avoid so many of the negatives of today's society. Mainstream media talks of specific narratives while social media influencers hype (pump and dump) stocks, commodities and crypto. Technical analysis helps investors avoid these pitfalls by focusing purely on the charts.
Verified Investing is dedicated to helping investors understand, learn and profit from technical analysis.
