Traders have debated the merits of "technical analysis" versus "fundamental analysis" for years. In reality, most traders probably do not make such a rigid distinction between these two approaches to market analysis and use some of both in making their decisions.
Fundamental analysis studies factors such as supply, demand, weather, political developments, economic reports and the like to come up with their forecast for potential price direction. But many traders do not have access to all of the vast amount of fundamental information available nor do they have the ability to interpret the significance of much of this information on the market they are trading. Conclusions from fundamentals tend to be quite subjective.
Instead of trading to digest all of this fundamental information and convert it into an opinion on prices, those who use technical analysis believe that everything that is to be known about a market is incorporated into one thing, price, and look only at data generated by the action of the market itself. The technical trader's main resource is a price chart, which shows visually what has happened to prices historically and, based on past market action, what is likely to happen when the same conditions arise in the present.
Even the staunchest advocate of market fundamentals is likely to refer to a price chart before making a trade, if for no other reason than to get some perspective on how current prices fit into a market's price history. By the same token, even the most dedicated follower of technical analysis is likely to keep in mind the importance of key fundamentals such as natural disasters, political upheavals, major economic reports, etc.
This trading tutorial focuses on the basics of technical analysis, which involves several underlying assumptions:
- All fundamentals or any other inputs known to the market are reflected in price.
- History repeats itself so that a study of what prices did in the past can provide clues about what they will do in the future.
- Prices tend to move in trends - up, down or sideways - and changes in existing trends provide potential trading signals.
Technical analysis can be rather simple or quite complex, depending on the capabilities you have to manipulate the market data. The "primary" trading tools include basic chart patterns, such as triangles, double tops and bottoms, head-and-shoulders, flags, pennants and, of course, one of the most basic, yet most powerful, trading tools, the trend line. As long as you have the relevant price data, these basic tools do not even require a computer although a computer does make analysis much faster and easier.