Introduction to Technical Analysis

Theory
For the majority of people, the theory and the easiest issues are boring. We usually immediately want to know the complicated theories and techniques, to which only few people have access. Although we do not bring their effectiveness into question, only few people are aware of the fact that the strength of technical analysis lies in an appropriate use of many simplest techniques and their combining into a single comprehensive strategy.
Nearly everyone can draw a trend line or notice that a given oscillator is overbought. Thus, it seems that it doesn’t take much time to learn the technical analysis and its basics are banal. The majority of people only skim the first pages of the handbook to learn the advanced techniques as fast as possible. The majority of fledging traders falls into this trap. It turns out later that drawing a line on a chart or stating that that an oscillator is overbought is too little to defeat the market. A given line can be drawn in a couple of ways and an overbought oscillator, without any clear reason, once announces immediate correction or five next times gives misleading signals. To know which line is important and when a purchase of an oscillator forecasts a return on the market, one should learn the boring basics.

The Art of Technical Analysis
With developing computerization, the technical analysis becomes more and more quantified. Nevertheless, it may be still said, that it stands between art and science. It results in many misleading notions about it. They should be cleared up once and forever. Technical analysis is neither a meta-physical chart fortune-telling nor a strictly scientific fortune-telling.
Although there are theories of technical analysis, which use the planetary system and moon phases, their grounds are based only on statistical correlations, which are proved only in a smaller or a bigger part. On the other hand, even the best computers calculating the most complicated mathematical patterns or neural networks are not able to foresee the future. The whole art is to skillfully combine the observed correlations and statistical dependence into a whole which enables to state the probability of price changes on the stock exchange.
It is worth stressing once again that it is only an attempt to determine the probability! There are no wonderful indicators, systems or theories, which would prove right every time and on all markets. Moreover, they even do not prove right every time on a single market. The risk of loss is calculated within the job of a stock exchange trader. In 10 transactions, from 3 to 7 show a loss. We cannot do anything about it, the only thing we should do, is to try to minimize losses and maximize profits.
We would like to warn everybody not to search for an indicator or a system, which would always bring profits. They don’t exist and we should understand that part of our transactions will always show a loss. The most important thing is to control the situation all the time to know whether a given loss is a result of a wrong trading strategy chosen by us and it should be improved or whether it is calculated within the principles of the strategy and due to the given market conditions it had a right to occur.

What underlies the Technical Analysis
To be able to comprehensively use a given tool, one should familiarize oneself with its operating manual. It is also the case with the technical analysis. Although we are able to draw the trend lines and properly interpret the behavior of indicators, we should be aware of the fact, what is really being interpreted, to understand the market better and the tools we are about to use. And it is not about the price!
The subject of technical analysis is the study of relation between demand and supply. This “battle” between the buyers and the sellers lies in the centre of interest of a technical analyst. The price, and more precisely its changes, are only a resultant of traders’ behavior. While interpreting the chart, one should always take into consideration the traders standing behind it, who on the one hand want to make profit and on the other hand are afraid of a loss!
The above mentioned principle facilitates the market analysis a lot. We stop guessing, how the price may behave, and we try to understand the situation of given traders and try to foresee their behavior.

Basic principles of Technical Analysis
Technical analysis is based on three basic principles. Although they are described in nearly all materials concerning basics of technical analysis, they are worth mentioning once again. They are a foundation, on which technical analysis is based.

1. The market discounts everything
All information concerning financial, macro-economic, fate and emotional or other matters are always reflected in the price behavior.

2. The history tends to repeat itself
On the price charts, recognizable and reoccurring formations irrespective of an adopted time horizon, can be found.

3. Prices are subject to trends
In the majority of cases, prices move in easily noticeable trends.

In the light of the above, the technical analysis may be used on nearly every market, within different time frames. The same rules are also applied with respect to five-minute, daily and monthly charts. In all trading horizons, we will find the same formations and signals of purchase and sale.
It doesn’t mean, however, that technical analysis will prove right to the same great extent. There are markets, on which the risk of loss is higher than on other markets. Factors characteristic of such markets include low liquidity, high inflow of fundamental information, fate factors and insider trading.