Technical Analysis Simplified #2
Hello all!
What we're doing in this series is giving you some very brief lessons on Technical Analysis that will hopefully make the topic less frightening/overwhelming and make it easier to understand. We'll have a TA guide developed later on, but just think of this series as a "beginner" series developed with the purpose of giving you a very broad overview in preparation of a more detailed guide at the "novice" level.
Let's get started on part 2!
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Last time we touched on the issue of "market efficiency", but let's expand on this a little bit. A fully efficient market is one where the security's (stock, commodity, or any tradable investment) price is an accurate reflection of its fair value. Theoretically, there are 3 levels, or 3 different views on weather markets are efficient or not. We'll focus on two for now. Strong-form (technical analysts) and weak-form (fundamental analysts).
Technical analysts believe that the current price reflects all the information available regarding a security. Fundamental analysts believe that the current price of a security does not reflect its actual fair value, that the price can NOT be determined using past prices, that only using financial models to analyze certain financial data can the value be determined and anomalies between fair value and price be exploited for financial gain.
Let's switch now to digging a bit deeper into the Strong-form view, or the view of technical analysis.
One thing to stress right in the beginning (given that most of you reading this are interested in trading cryptocurrencies, probably) is that technical analysis is NOT meant to be an absolute prediction of the future. Rather, it is meant to help us anticipate what is LIKELY to happen in the future. We suggest you take a minute and re-read this sentence a few times to help it stick. Anyways...
Technical analysis can be applied to anything where the price is influenced by supply and demand (sellers and buyers) and is applied over a specific timeframe (that can be from a few minutes to several months or years).
Technical analysis also has a few assumptions in order for it to "work". First, it assumes that there is high liquidity for the security under analysis. This basically means that there is high volume, or that a large enough number of buyers and sellers are present. If there is low liquidity (not enough people buying and selling), technical analysis becomes much more difficult to conduct. For example, compare Bitcoin to REPO. At the time of writing, the 24 hour volume for REPO was $9,147, while for Bitcoin it was $3.8 billion! It's much easier to conduct technical analysis on Bitcoin than it would be on REPO...
Second, TA assumes that there are no "artificial" price changes. In the world of stocks, that means splits/distributions etc etc, but in the world of cryptocurrencies, what that usually means is the weird action we sometimes see on exchanges where the price "spiked" to an insane level (up or down) before going back to where it was. On stock exchanges, there are mechanisms in place that prevent that from happening, but on crypto exchanges, not so much. Once you get a bit deeper into crypto trading, you'll see how a lot of traders lose a lot of money because their "stop loss orders" got hit by a "spike", that's why artificial price changes are very dangerous. You'll now see that one fundamental assumption of TA is automatically absent for crypto, that just shows you how dangerous it can be...
Third, TA assumed that there are no extreme news. Of course, as analysts (and if we're trading stocks) it's hard for us to forecast certain news like political distrubances, war, etc. These news affect the price of securities, and that's why when they do happen, analysts generally wait patiently for the dust to settle before resuming their analysis.
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Let's stop here and pick it up again in the third installment of this series!
As always, if you have any questions, don't hesitate to reach out via email or through our Telegram group! (links below)
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