Lecture 7

Introduction To The Technical Analysis, Dow Theory.

As you could observe in the previous lectures, the trade at financial markets intends the ability to predict the movement of the price, determine the possibility of trends changing, monitor the current situation and emerging changes which can influence the reversal of the further events. Different methods of analysis were created during the trade development at financial markets helping to predict the market successfully, which means to have a profitable trading. Since this lecture we begin to study these methods and the first of them will be Technical analysis.

Before we started to learn the methods and means used for the technical analysis of currency, commodity and other markets it is necessary, first of all, to determine where the technical analysis started from and what it really represents. In the middle of the 19th century a rapid development of organized market — places began, where the trading participants make deals with various material and intangible values by the uniform rules. A differential peculiarity of such markets is that a trading participant is not interested in who is the deal counterpart in 99% of cases but its main characteristics are the price and the volume. The exchange is a classic organized market.

This trading organizational chart sharply increases the possibilities of participants to  make deals — so - called market liquidity. Therefore, a lot of trading participants had the bait not only to buy or sell certain goods for an applicable price, but to sell it more high — priced — to trade at the market. In order to achieve success in this no picnic, it is necessary to forecast the market behavior in the future — to make a good prediction and thereunder to sell, buy or do nothing.

In the first instance there were as many forecast methods, which were used by market participants, as participants themselves. Time passed, some of methods faded and others became popular and was in progress. Eventually, methods of market analysis divided into two extensive branches: a fundamental analysis and technical analysis. What do they mean? The fundamental analysis uses factors for market predictions closely related to the trade subject — economic, politic. The technical analysis is based on the research of crowd behavior which is already known everything and which is taken into account all the factors made the market. From the viewpoint of technical analysis there are a number of patterns and dependencies confirming market behavior (in fact — the crowd of traders). The technical analyst does not try to understand why this creature has pulse 20 beats per month, while it responds to a prick made by needle in five minutes (this is a share of analyst — fundamentalist). He simply notes all these facts and uses them for prediction of this creature behavior in the future.

The technical analysis is not a science at present moment. Everybody thinks so, because intuitive to many professionals regularities of market behavior have not explicitly taken out yet. Generally, the technical analysis is only a convenient tool for market data presentation. To read these data is a skill, although the word «science» appears more often in literature about the technical analysis, for example, the well — known analyst Tomas Demark called his book «Technical analysis — a new science».

The basic data for the technical analysis are only two characteristics, they are the commodity price and the transactions volume with it. Moreover, even these two characteristics by themselves are not interested, we are interested in their behavior in time. Simply speaking, in the chart of price and transactions volumes made with an asset over the definite period of time. It is considered, that this set presents the history of market behavior provides all necessary things you need to analyze and predict its behavior.

Why is the technical analysis so popular among professionals for more than a century? Because it is so extensive, flexible and utility! Judge youself:

• methods of the technical analysis are suitable at any market, whether they are soybeans trading, corporative shares or currencies (at each market some methods work better, others — worse and some of them do not work at all);
• an experienced stock jobbler works at many markets all at once, trying to fatten his or her profit and decrease losses, so he/she has no time to analyse thoroughly each of them, while the technical analysis is the only way to follow all markets of interest, so to say, via one «window»;
• nowadays, there are so many methods of the technical analysis that the analysis by itself can be regarded as a certain erector, using parts of which any person can create his/her own unique system;
• finally, the technical analysis is a creative work which can sweep anyone, but with a reasonable approach — realize a solid profit.

Technical analysis is a reseach of the market dynamics by means of diagrams, in order to predict the future trend of price movement.

The term «market dynamics» includes three main information sourses which a technical analyst has at disposal, such as price, volume and open interest. According to the fact that it is rather difficult to determine the actual volume and open interest at the foreign exchange markets, the major sourse for us will be the price. Hence is another definition:

Technical analysis is a study of past price movements to predict futher ones. The price movement is the most important statistics in the world of technical analysis, as it is the only exact measure of investors sentiment, reflecting the conjunction of supply and demand.

The technical analysis by itself is free of win — win trading secret and is not a panacea for a trader. However, it can help a calm and serious — minded trader to see a real picture of what is happening at the market and to take an adequate decision.

In this technical theory, as in any other one, there are basic postulates.

The basis of the technical analysis theory is based on ideas formulated by one of the major developers of modern technical analysis Charles Dow, who invented the world's most famous stock index Dow-Jones. You can learn more information about Dow Theory at InstaForex training website: http://www.instafxeducation.com/dow_theory.php

Let us examine these postulates in more detail, there are three of them.

Market movements are considered by everyone. This postulate is the most important in the technical analysis, its meaning is necessary for adequate perception of all analysis methods. Its main point is that any factor influencing the cost of security - economic, political, psychological - are previously taken into account and reflected at the price chart. In other words, at any price change is an appropriate change in external factors. The main consequence of this factor is the necessity to monitor and study the dynamics of price movements. Analysing price charts and a great deal of additional indicators, a technical analyst obtains that the market itself indicates him the most likely direction of the movement. This factor conflicts with the fundamental analysis, which focuses on the study of the factors after the analysis of which   conclusions according the market motion are appeared. So, if the demand is outgrowing the supply, then the fundamental analyst makes a conclusion that price has been increased. The technical analyst also makes a vice versa conclusion that, if the price increases, then the demand is outgrowing the supply.

Prices move around directionally.

This assumption was the basis for the establishment of all technical analysis methods, in far as the market affected by trends unlike the chaotic market can be analyzed. There are two consequences from the statement that price motion is submitted to trends. The first consequence is that the current trend is more likely will further be in progress and will not become the opposite of its own, so by this consequence the chaotic market motion is excluded. The second consequence said that the current trend will grow until the movement in the opposite direction starts.

History repeats itself.

The technical analysis and studies the market dynamics are closely connected with the study of human psychology. Thus, graphic pricie models which have been identified and classified in the last hundred years, reflect the most important features of the psychological market state. First of all, they indicate what kind of the moods — bullish or bearish are currently dominated at the market. And if in the past these models worked, there are good reasons to assume that they will work in the future, because they are based on human psychology, which does not change as the years go by. It is possible to represent the last "history repeats itself" postulate in a few other words - the key to understanding the future lies in retrospective researches.

Assignment for submission.

1. Which two branches of analysis are existed?
2. What is technical analysis?
3. How to understand the postulate «History repeats itself»? Give examples of everyday life.
4. What is the main object of technical analysis studying?

List of recommended literature:

http://instafxeducation.com/en/elliott_wave_theory.php
http://instafxeducation.com/en/theory.php