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When it comes to speculating or investing in the financial markets, there are two main approaches. The first is fundamental analysis, and the other is technical analysis. These fields of study are different. Yet they point to the same goal of buying low and selling high.
In forex, technical analysis is the go-to form of study. This form of analysis is the study of past prices for the purpose of predicting future price movements. To conduct this form of analysis, traders focus on a number of methods. For example, they study chart patterns or use technical indicators derived from price. These methods help them to understand what the price will do.
In a way, technical analysis is predictive in nature. It can tell you, with some amount of confidence, where the price will be based on past price behavior.
Technical Analysis vs. Fundamental Analysis
Traders often debate about which of these two types of analysis is better. The truth is that in order to understand the full scope of the markets, you need both technical and fundamental analysis.
Fundamental analysis deals with understanding and studying the reasons behind the price behavior. On the other hand, technical analysis is all about understanding what the price will do.
You Need Both Forms of Analysis to Fully Understand the Market
It’s important to understand one of the main differences between technical and fundamental analysis. This is that fundamental analysis is subjective in nature. Moreover, a trader’s interpretation can vary depending on the amount of information he or she has.
Contrarily, technical analysis is objective. However, sometimes it works and sometimes it doesn’t. It is only when you combine the strengths of both these forms of analysis that you get a full picture of the market.
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Does Technical Analysis Work?
The answer to this question depends on how you apply this approach. For example, you can be a trader using technical analysis on a five-minute chart. Meanwhile, another trader can use the same study but on a larger time frame.
The goal with both these different approaches is basically the same, which is to identify what the price will do and then determine if it would be ideal to buy or sell.
Up to a certain point, technical analysis can work for traders. This is because you are, after all, studying the price of the security in question. However, you must remember that the price that is reflected on the chart basically depicts traders’ sentiment behind it.
Also, in a sense, technical analysis is one way of studying the market sentiment along with the trader’s view of the security in question. But patterns tend to repeat themselves over time, and a technical point of view capitalizes on this.
An Example to Provide Clarity
As an example, let’s say you see a bearish engulfing pattern on a price chart that forms near a resistance level. Therefore, you know the price is more likely to fall than to rise. However, this can come across as something mysterious.
On the other hand, if you scratch the surface, this bearish engulfing pattern simply reflects the bearish sentiment in the market. Then, when you combine this view with the fundamentals behind the price behavior, you can better understand what you’re seeing.
It’s Not All About Buying and Selling
For many traders who use automated trading strategies, technical analysis boils down to buying and selling based on the indicators they use. However, this is a rather simplistic view. It’s important to remember that the buy and sell signals are derived from price itself.
As we know, the price is set by the markets. The markets, in turn, are made up of buyers and sellers. Therefore, technical analysis really isn’t all that mysterious. It simply puts the market sentiment in perspective.
All the same, there are times when technical analysis can fail. One of the reasons for this is that the markets are often adjusting to the news. Therefore, when there is a mismatch between the market’s expectations and the fundamentals, the price can behave erratically.
In order to make technical analysis work, traders need to have a full understanding of the markets. This includes using both technical and fundamental analysis. Remember that both of these forms of study complement each other rather than giving opposing views.