Does Technical Analysis really deserve trust? A comprehensive guide to understanding its tools and limitations.

Why do some people doubt Technical Analysis?

Before diving into the details of how to use Technical Analysis, it is important to understand the criticisms directed at it. Critics argue that this analysis works only because thousands of traders use the same indicators, resulting in predictions that are inherently predictable - what is known as a “self-fulfilling prophecy.” When millions of people expect the price to rise at a certain level, it may indeed rise not for real reasons but because everyone is buying at the same level.

Moreover, interpreting charts is not an exact science - one trader may see a buy signal while another sees a sell signal. Technical analysis may also fail completely during periods of financial crises or unexpected events that shake the market violently.

What is Technical Analysis? And how did it emerge?

Despite the criticisms, Technical Analysis continued to spread and evolve. This method relies on studying historical price movements and trading volumes to predict future trends. Unlike fundamental analysis, which seeks the “true value” of an asset through financial data, Technical Analysis focuses on what is actually happening in the market - namely the behavior of traders and investors.

The historical roots of Technical Analysis date back to ancient times. Primitive forms of it appeared in Amsterdam in the 17th century and in Japan in the 18th century, but the modern version is attributed to Charles Dow - the financial journalist who founded The Wall Street Journal. Dow observed that markets and individual assets typically move in measurable and analyzable trends, which later led to the development of Dow's theory that formed the basis of modern Technical Analysis.

In the beginning, traders used to do all the calculations manually. But technological advancement changed everything - computers and software made Technical Analysis accessible to millions, transforming it from an elite specialty to a daily tool used by most traders.

How does Technical Analysis work in practice?

At the heart of Technical Analysis lies a simple assumption: the current price already reflects all available information. Therefore, by studying price patterns and trading volume, a trader can predict what might happen next.

But this is not magic. Technical Analysis actually measures the underlying market forces: supply and demand. When the price rises, it means that buying forces are stronger than selling forces. The reverse is true when it falls. These forces are directly linked to traders' emotions - primarily fear and greed.

It is important to understand that Technical Analysis works best in liquid markets with high trading volumes. When there are a large number of traders and a huge trading volume, it becomes very difficult for a single player or a small group to manipulate the price. In contrast, small markets with limited liquidity may be susceptible to manipulation and false signals.

Basic Technical Analysis Tools Used by Traders

Traders have a variety of tools at their disposal. Some are very simple, while others are complex. Let's review the most commonly used ones:

Moving Averages - Noise Filtering for Clear Vision

The Simple Moving Average (SMA) calculates the average closing price over a specific period, such as the last 20 days. The benefit? It removes the “noise” - those random daily fluctuations - and shows the true trend.

The Exponential Moving Average (EMA) does something similar, but it gives more weight to recent prices. This makes it more responsive to new movements, which can help traders detect changes more quickly.

A popular strategy called “Golden Cross” occurs when the short-term moving average crosses above the long-term moving average - this is considered a strong buy signal. Conversely, when the short-term average falls below the long-term average (Death Cross), it may indicate a selling opportunity.

Relative Strength Index (RSI) - measuring extremes

This indicator measures price momentum on a scale from 0 to 100. Readings above 70 indicate that the asset may be overbought ( and a decline may occur soon ), while readings below 30 indicate overselling ( and a rise may occur soon ). The idea is that extreme prices do not last long - they often reverse themselves.

Bollinger Bands - Understanding Volatility ###

This indicator consists of three lines: a middle line (moving average) and two bands that surround it. These bands expand and contract according to market fluctuations. When the bands widen, it means the market is volatile. When they narrow, it indicates market calmness and may precede a major movement coming.

MACD Indicator - Linking Moving Averages

This indicator shows the relationship between two exponential moving averages. When the MACD line crosses above the signal line, it may indicate an upcoming bullish trend. When it crosses below, it may indicate a bearish trend.

Signals and Critical Points

Indicators do not only tell you about trends - they can also provide you with specific “trading signals”, meaning potential entry and exit points.

For example, when the RSI rises above 70, this is a potential sell signal. When it falls below 30, this is a potential buy signal. The moving averages crossover ( the golden crossover and death ) are also very famous signals. Even the MACD gives signals when its lines cross.

But - and this is a critical point - not all signals are correct. In fact, a large number of signals produced by indicators can be completely wrong, especially in very short time frames or in low liquidity markets. Therefore, wise traders use what is called “multiple confirmation” - meaning they do not rely on a single indicator, but look for confirmation from several sources before entering any trade.

Technical Analysis vs Fundamental Analysis - Which One Do You Choose?

This question occupies every new trader. Fundamental analysis seeks the “true value” of the asset - looking at profits, debts, competitive advantages, and economic indicators. It tells you: “Is this asset fairly valued or not?”

Technical Analysis does not concern itself with any of this. It only asks: “Where is the price headed in the short term?”

The result? Fundamental analysis is better for long-term investment - if you plan to hold an asset for years. Technical analysis is better for short-term trading - if you are trying to take advantage of daily or weekly price movements.

The truth? Most successful traders use both together. They use fundamental analysis to select good assets, and then they use technical analysis to determine the perfect timing for entry and exit.

Summary - Is Technical Analysis Worth Your Time?

Technical Analysis is a powerful tool, but it is not a crystal ball. It works best when there is high liquidity and when the trader uses it wisely. The most important thing is to understand its limits: signals can be wrong, crises and unexpected events can occur, and prices may not always reflect all information perfectly.

But when technical analysis is combined with strong risk management, multiple confirmations, and fundamental analysis, it can be a very effective weapon in any trader's arsenal. The key is not to rely on it blindly - but to use it as part of a bigger picture.