Philosophy of Technical Analysis
Since the existence of the stock market, two well differentiated schools have appeared, which try to solve the main problem that the investor has. That is:
What to BUY or SELL and when to do it.
Technical Analysis is the study of the market’s action through the use of charts that reflect the prices of a stock, its volume, etc…, in order to determine future price trends . It is based on the following points:
a) Market action discounts everything.
The technical analyst thinks that everything that can influence the price of a market share is reflected in that price. Future trends can be predicted by studying the graph containing those prices.
The fundamental analyst thinks that the market share is the reflection of movements in the Supply and in the Demand: if the demand exceeds the supply the prices go up and if the supply exceeds the demand they go down.
Technical analysts reverse this reasoning and think that if prices rise (for whatever reason) it is that demand exceeds supply, so we are in a bullish situation, and if the opposite occurs, i.e., that supply exceeds demand, we would be in a bearish situation.
- b) Prices move by trends.
The concept of trend is, without a doubt, the most important in technical analysis, since the purpose of any technical study is to identify in which trend prices move to try to take positions at the beginning of that trend.
c) History repeats itself
Technical analysts think that if certain chartists and certain indicators and oscillators have worked well in the past, why won’t they do so in the future?
Critics of technical analysis believe that since technical analysis has become so widespread in recent years, and many traders have graphic tools at their disposal, it could be that many buy or sell orders are the result of different bullish or bearish patterns.
Another criticism that is often made is that chartist figures are very subjective, that is, where one analyst sees a certain figure another may not see it.
It is evident that these critiques are contradictory since, in the first one, it is indicated that the technical analysis is objective and in the second one that it is subjective.
It is also often criticized for the fact that history repeats itself, but it must be taken into account that there is no method of prediction (meteorological, statistical, clinical, etc…) that is not based on past events.
Until relatively recently, the terms technical analysis and chartist analysis meant exactly the same thing, but currently, due to the incorporation of various mathematical and statistical models, there are important differences.
The chartist analyst’s main working tool is the graph that reflects the prices of a given stock. By studying the different chartist figures that are formed in the chart, he tries to predict the future trend.