Technical Analysis although primitive forms of technical analysis emerged in 17th-century Amsterdam and 18th-century Japan, the concept of modern Technical Analysis can be traced back to the work of Charles Dow. Dow, is a founder of The Wall Street Journal and financial journalist. He was the first to notice that individual assets and markets often move in trends that could be dissected and examined. His work later became known as Dow Theory, which led to the development of technical analysis later.

In the early stages, technical analysis was conducted based on a hand-made sheet and manual calculations, but with the development of technology and the advancement of modern computing, technical analysis has greatly improved and is now an important tool for many investors and traders.

Technical Analysis (TA) is also often called charting. It is a type of analysis that predicts future market behavior based on past price action and volume data. The TA method is widely applied to stocks and other assets in traditional financial markets, but it is an integral component of trading digital currencies in the cryptocurrency market.

Technical Analysis (TA) focuses strictly on historical price action, whereas Fundamental Analysis (FA) considers multiple factors surrounding an asset's price. FA is, therefore, a tool for examining an asset's price movements and volume data, and many traders use it to identify trends and favorable trading opportunities.

How does Technical Analysis work?

Technical analysis is essentially the study of the current and past price of an asset. The main underlying message of technical analysis is that the price of an asset does not fluctuate randomly, but usually develops in identifiable trends over time.

The main function of TA is to analyze the market forces of demand and supply, which provide a picture of the overall market sentiment. In other words, Technical Analysis reflects the buying and selling forces against the price of an asset, and these forces are closely related to the emotions of traders and investors (mainly fear and greed).

Notably, TA is considered more reliable and effective under normal conditions with high volume and liquidity in markets. High-volume markets are less susceptible to price manipulation and unusual external influences that can create false signals and render TA ineffective.

To monitor prices and ultimately find favorable conditions, traders use various charting tools known as indicators. Technical analysis indicators help traders identify existing trends and provide insight into potential trends. Since TA indicators have some drawbacks, some traders use multiple indicators as a way to reduce risk.

Common Technical Analysis indicators

Basically, traders use Technical Analysis to determine market trends based on charts and historical price action a variety of indicators and metrics. The Simple Moving Average (SMA) is one of the most widely used and well-known examples of numerous technical analysis indicators. The SMA, as its name suggests, is calculated based on the closing price of an asset over a specified period of time.

The Exponential Moving Average (EMA) is an upgraded version of the SMA that importance recent closing prices more heavily than the older ones.

The Relative Strength Index (RSI), also known as an oscillator, is a commonly used indicator and part of the same class of indicators. Oscillators apply mathematical formulas to pricing data and produce readings that fall within a predefined range, unlike moving averages that simply track price changes over time. In the case of the Relative Strength Index (RSI), this range fluctuates from 0 to 100.

Another popular oscillator type among traders is the Bollinger Bands (BB) indicator. The BB indicator is built on a moving average line that is formed by two lateral bands. It is used to measure market volatility and identify potential overbought and oversold market conditions.

In addition to the basic and common TA tools, there are some indicators that rely on other indicators to generate data. For example, the Moving Average Convergence Divergence (MACD) indicator is another popular indicator. In addition, the Stochastic RSI is calculated by applying a mathematical formula to the regular RSI. The MACD is created by subtracting two EMAs. The first line is used to create another EMA, resulting in the second line known as the signal line. There is also the MACD histogram, which is calculated based on the difference between those two lines.

Trading signals

While indicators are effective for marking general trends, they can also be used to provide insight into potential entry and exit (buy or sell) points. These signals can be generated when certain events occur on an indicator's chart. For example, if the RSI score produces a reading of 70 or higher, it signals that the market is operating under overbought conditions. Conversely, if the RSI score is 30 or lower, the same logic applies, meaning that the market is considered to be oversold.

As mentioned earlier, trading signals provided by technical analysis are not always accurate, and there is a lot of noise (false signals) produced by TA indicators. This is especially true for the volatile cryptocurrency market, which is much smaller than traditional markets.

Criticism

Although TA is widely used in all types of markets, many experts consider it a controversial and unreliable method. Some experts also consider it a "self-fulfilling prophecy." This term is used to narrate events that only happen because a large number of people predict that it will happen.

Critics believe that, in the context of financial markets, if a large number of traders and investors rely on the same type of indicator at support or resistance lines, then the likelihood of these indicators working increases.

On the other hand, many technical analysis proponents believe that there is a specific way to analyze each chart and use the many indicators that exist. This means that it is practically not possible for a large number of traders to use the same specific strategy.

Difference between Fundamental Analysis and Technical Analysis

The central premise of technical analysis is that the market price already reflects all the fundamental factors related to a particular asset.

However fundamental analysis focuses primarily on historical price data and volume (market charts) and adopts a broader investigative technique that places more emphasis on qualitative factors.

Fundamental Analysis considers the reliance on an asset's future performance rather than historical data. Essentially, FA is a method used to make predictions based on a company's business or company's management and reputation, market competition, growth rate, and industry health.

Therefore, we can consider that Fundamental Analysis (FA) is a technique to determine whether an asset is overvalued in terms of its context and potential, in contrast to Technical Analysis (TA) which is mainly used as a predictive tool for price action and market behavior. While technical analysis is used by most short-term traders, fundamental analysis is preferred by fund managers and long-term investors.

A significant advantage of technical analysis is that it provides a framework for an objective investigation of price history, eliminating some of the assumptions that come with the more qualitative approach of fundamental analysis, and it relies on quantitative data.

However, despite working with empirical data, TA is still influenced by personal biases and egocentrism. For example, a trader who strongly relies on TA tools to support their biases in reaching a particular conclusion about an asset will likely be able to reflect their preconceived ideas, and in many cases this happens unconsciously. Furthermore, technical analysis is also likely to fail where markets do not present a clear pattern or trend.

Conclusion

Although there are many opinions and long-standing debates about which method is better, a combination of both TA and FA methods is considered by many to be a much more suitable choice. While FA is generally associated with long-term investment strategies, TA can provide insightful information on short-term market conditions and attempts to determine optimal entry and exit points, which can be useful for both traders and investors.