Why traders use technical analysis
Every trader has their own view on the type of analysis they want to utilise to help them develop their edge. As you become more experienced you will form your own views as well – when you do this try not to base this on the outcome of a few trades, rather the performance over the long term.
Technical analysis, among other things, helps traders with timing, something fundamental analysis struggles with. This is the #1 reason traders use it – for a margin trader using margin, and having to fund the leverage, timing is important.
With its use of charts, technical analysis is very visual, this makes it easier to get started with for new traders.
The limitations
We’d be remiss not to explain the limitations of technical analysis.
- Going back to the first core assumption, we think making the assumption that the market fully discounts all information in all circumstances isn’t quite practical. Most of the time in large liquid markets we think it is reasonable to make this assumption but if you are blind to the fundamentals then in some circumstances, when information isn’t fully factored in, the edge sound technical analysis creates is lost. The ‘why’ of trading is important as well and we have built top-down fundamental analysis into the trading approach we teach.
- Technical analysis is therefore considered more effective in large more liquid markets, like fx majors and popular indices. It is less suited to illiquid markets like small-cap shares. In these markets, we think a bottom-up fundamental analyst will have more of an edge because it is less likely the information they are analysing has been factored into the price.
- All analysis methods are subjective, with no absolutes. Technical traders deal in probabilities and not certainties.
No secret formula
Unfortunately, there are no secret formulas in trading – it is like any other skill, you need to:
- Take the time to learn it properly. Don’t look for shortcuts.
- Build up layers of evidence before a trade. Do this using a range of proven analysis techniques.
- Find setups where the risk to reward ratio is in your favour. Do this consistently and this becomes a profitable strategy.
- Apply good money management rules. Accept you are dealing in probabilities and you can be wrong. Accept you will make mistakes, especially at the start of your trading career.
- Manage your emotions – greed and fear being the main ones.
- Technical analysis provides a fantastic insight into the timing of a trade, something fundamental analysis struggles with.
- There are limitations to all techniques, the assumptions behind technical analysis are harder to make in illiquid markets where information is less likely to be priced in.
- There is no secret formula to trading, just hard work, it is just like any other skill.
- The approach we teach uses technical and top-down fundamental analysis.
