Topic 1 – Background to Technical Analysis
TA approaches the decision making process by examining the market for the financial instrument itself. The data from the market are primarily the price, volume and, in futures markets, the open interest. TA is not concerned with the value of whatever underlies the financial instrument, but with how the forces of supply and demand are impacting upon its price.
Fundamental & technical analysis are complementary.
The funda approach tends to tell us what should happen to prices. The TA approach tries to tell us when the price change begins & ends.
Technical analyst vs chartist
Trading or investing successfully in financial market involves two different types of skills: analysis – the formulation of an opinion about the market; trading – the execution of buying and selling strategies in the market. The skills of the analyst and of the trader are different and many find it difficult to be good at both activities.
Trading vs investing:
Trading focuses on capital gain.
Investing focuses on the generation of income stream where capital gain is secondary. However, most activity involves a combo of both. But with the TA, it almost entirely emphasise on capturing a capital gain since it deals with changes in prices.
Most TA are able to analyse unfamiliar markets using the tools they are familiar with as TA is relevant to all markets and all timeframes.
The art of TA is to identify trend changes at an early stage and to maintain an investment posture until the weight of evidence indicates that the trend has reversed. TA is the study of the actual movements in the price of the stock, commodity or currency to gain an insight into future or potential market action of price trends. TA is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends (where) market action includes the three principal sources of information available to the technician – price, volume and open interest. TA is the study of past market behaviour to determine the current state or condition of the market. There is a lack of consensus of what TA is, because TA means different things to different people and few make a clear conceptual distinction between the analysis process and trading process. The most important element is that TA is the study of the way market participants are reacting to the market, which in turn forms market action. For the technical analyst, the explanation for market action lies in understanding the behaviour of market participants, rather than the study of changes in value of the underlying asset. The study of behaviour of market participants, as reflected in price, volume and open interest for a financial market, in order to identify stages in the development of price trends.
The way TA look at markets is based upon 3 important assumptions about the way all markets operate: (details see pp.1-7,8,13) ◆ The market price discounts everything that drives buyers and sellers. ◆ Prices are not entirely random and move in trends for significant periods of time ◆ Human nature is constant, resulting in recurring behaviours in response to similar situations and thus generating repetition of certain price patterns.
TA is only concerned with the secondary market.
TA primary focus on ordinary shares, other classes will only where trading is sufficiently active. Market indexes are used as a benchmarks and often is the base of derivative markets.
Go long means buy now and sell it later to make profits.
Go short means sell now then buy it later at a lower price to make profits. Call = long; put = short.
In theory, long position has limited financial loss but unlimited potential profits, where short position has only limited profits but with unlimited potential losses.
It is possible to short sell Australian shares and it happens all the time. The advantage may lie in the fat that markets generally fall much more quickly...
Please join StudyMode to read the full document