What is Technical Analysis? Basics and How to Utilize It for Beginners

In financial markets such as stocks, forex, and cryptocurrencies, "technical analysis" is one of the analytical methods widely used by many investors to make investment decisions. However, many may feel intimidated by complex charts or an abundance of specialized terminology, making it difficult to take the first step.

This article will explain the fundamental concepts of technical analysis, its representative indicators, and its benefits and limitations, all in an easy-to-understand manner for beginners. By reading this article, you will gain an overall understanding of technical analysis and be able to take the first step towards using it to enhance your investment strategy.

What is Technical Analysis? Its Essence and Purpose

Technical analysis is a method that attempts to predict future price movements by analyzing past market data (charts) such as stock prices, exchange rates, and trading volumes. While fundamental analysis focuses on "intrinsic value" based on corporate performance and economic indicators, technical analysis focuses on the "price movement itself," which reflects the psychology and behavior of market participants.

Fundamental Principles of Technical Analysis

Technical analysis is primarily based on the following three premises:

1. Price Discounts Everything: This principle suggests that all information influencing the market, such as company performance, economic indicators, and political situations, is ultimately reflected in the price. Therefore, analyzing price movements themselves is considered more efficient than analyzing individual pieces of information.
2. Prices Move in Trends: Once a price movement begins (uptrend, downtrend, or sideways market), it tends to continue for some time. Identifying these trends is one of the primary goals of technical analysis.
3. History Repeats Itself: Human psychology (greed and fear) remains constant across eras. Therefore, the market's reaction to specific chart patterns in the past is likely to repeat in the future.

Based on these principles, technical analysis is used to determine buying and selling timings and to manage risk.

Key Types of Technical Analysis and Practical Examples

There are numerous technical indicators, but here are a few representative ones. They can be broadly categorized into "trend-following" and "oscillator" indicators.

1. Trend-Following Indicators: Showing Market Direction

Trend-following indicators are used to determine whether the current market is in an uptrend, downtrend, or sideways movement.

• Moving Average (MA)
  • The Moving Average is a line connecting the average closing prices over a specific period. A "golden cross," where a short-term MA crosses above a long-term MA, is considered a buy signal, while a "death cross," where it crosses below, is a sell signal. It helps visualize trend direction and reversal points.
• Bollinger Bands (BB)
  • Bollinger Bands display a band (envelope) calculated by standard deviation above and below a moving average. Prices are likely to stay within the band, and a contraction of the bands (squeeze) suggests preparation for a trend, while an expansion (expansion) indicates an accelerating trend.
• Ichimoku Kinko Hyo (Ichimoku Cloud)
  • A unique technical indicator developed in Japan, consisting of five lines (Tenkan-sen, Kijun-sen, Senkou Span A, Senkou Span B, and Chikou Span) and a shaded area called the "cloud." It allows for a comprehensive judgment of trend direction, strength, and support/resistance levels. The "cloud" is particularly known to act as future support or resistance.

2. Oscillator Indicators: Showing Overbought/Oversold Conditions

Oscillator indicators are used to determine if the current price is overbought or oversold, suggesting a potential market reversal. They typically fluctuate within a range, often between 0% and 100%.

• Relative Strength Index (RSI)
  • A prominent indicator for identifying overbought and oversold conditions. Generally, an RSI above 70% indicates overbought, and below 30% indicates oversold, used to predict market reversals.
• Moving Average Convergence Divergence (MACD)
  • MACD uses the difference between two moving averages (MACD line) and its own moving average (signal line) to indicate trend direction and reversal points. A MACD line crossing above the signal line is a buy signal, while crossing below is a sell signal.
• Stochastics
  • Similar to RSI, Stochastics is an indicator for determining overbought and oversold conditions. It consists of two lines, %K and %D. Above 80% is considered overbought, and below 20% is oversold. A "golden cross" ( %K crossing above %D) or a "death cross" ( %K crossing below %D) are also used as trading signals.

3. Candlestick Analysis: Deciphering Market Psychology from Individual Candles

Candlestick charts represent four prices—open, close, high, and low—with a single candle. By analyzing the shape and combination of individual candles, one can decipher market participants' psychology and future price movements.

• Bullish/Bearish Candles: A bullish candle (often green or white) indicates that the closing price was higher than the opening price, while a bearish candle (often red or black) indicates a lower closing price.
• Representative Patterns: Various patterns like "engulfing patterns," "doji," "hammer," and "hanging man" exist, each suggesting specific market psychology or reversal points.

Benefits and Limitations of Technical Analysis

Benefits

• Objective Decision Criteria: Allows for trading decisions based on clear chart signals, rather than emotions.
• Timing Trade Entries and Exits: Helps pinpoint specific entry (buy) and exit (sell) points.
• Applicable Across Various Markets: Can be used in any market where price data is available, including stocks, forex, commodities, and cryptocurrencies.
• Risk Management: Provides benchmarks for setting stop-loss and take-profit levels.

Limitations and Caveats

• False Signals (Whipsaws): Technical analysis signals are not always correct. They may fail, especially in sideways markets or during sudden news events.
• Lagging Nature: As it's based on past data, it cannot immediately react to real-time sudden news or events.
• Not a Standalone Solution: Relying solely on technical analysis for investment decisions is risky. It's crucial to combine it with fundamental analysis, economic news, and other information for a comprehensive assessment.
• Learning Curve for Beginners: The sheer number of indicators and the need to understand their characteristics and combinations require time and experience.

Steps to Get Started with Technical Analysis

1. Acquire Fundamental Knowledge: Learn the basic meanings and uses of each indicator through books or online courses on technical analysis.
2. Utilize Charting Tools: Start practicing chart interpretation using free tools provided by brokerage firms or specialized charting platforms like [Affiliate Location: TradingView].
3. Practice with Demo Trading: Apply your learned knowledge risk-free using virtual funds in a demo trading environment. It's essential to experiment with various indicators to find methods that suit you.
4. Start with Small Amounts in Live Trading: Once you feel confident with demo trading, begin actual trading with a small amount of capital. Emotional control is also a crucial factor.
5. Continuous Learning and Improvement: Markets are constantly evolving. Continuous learning and regular review of your trading methods are key to success.

Conclusion: Technical Analysis as a Powerful Investment Tool

Technical analysis is a powerful tool for objectively analyzing market price movements and aiding investment decisions. While not infallible, understanding its fundamental principles and key indicators, and combining it with other information, can help you build a more informed investment strategy.

It may seem challenging at first, but with continuous learning and practice, your investment skills will steadily improve. Embrace technical analysis and approach the financial markets with confidence. However, remember that all investments carry the risk of capital loss. Always invest cautiously and at your own discretion and responsibility.