Every week we provide insights into popular assets and hot questions, so you can easily learn more about the investment market in bite‑sized pieces.
In this Markets in Focus, we take a closer look at technical analysis - how it works, where it comes from, and why it’s still relevant today.
What Is the Basis of Technical Analysis
Technical analysis has its roots in Dow Theory, developed by Charles H. Dow in the late 19th and early 20th century.
Dow’s theory provides a framework for understanding how markets trend, including phases of price action and how volume confirms moves.
While today’s technical analysis uses advanced tools and automation, many of its core concepts still rely on Dow’s original insights.
Key Principles of Technical Analysis
Modern technical analysis revolves around several core principles derived from Dow Theory:
- Charts Tell a Story
- Historical price data reflects supply and demand, market sentiment, and psychology. Analysts use charts to interpret past behavior and infer likely future movements.
- Market Trends Exist on Multiple Time FramesAccording to Dow Theory, there are three types of trends:
- Primary (major) trends - long-term movements that last from months to years.
- Secondary trends - corrective waves within primary trends, typically lasting weeks to a few months.
- Minor trends - short-term fluctuations, often less than a few weeks, considered “noise” by long-term analysts.
- Historical Patterns Repeat
- Price behaviors, chart patterns, and volume dynamics often recur over time. By studying previous price movements, traders aim to identify optimal entry and exit points.
- Trend Confirmation through VolumeVolume plays a key role in confirming price trends: when volume rises alongside a trend, it’s a sign of strength.
- In upward primary trends, volume should increase on advances and diminish on pullbacks.
- Conversely, in a downward primary trend, rising volume on declines helps confirm the move.
- Trend Persistence Until Clear ReversalDow’s theory holds that a trend remains valid until there is a clear signal that it has reversed. Identifying that reversal can be challenging - sometimes what looks like a new trend is just a secondary correction.
- For trend confirmation, Dow suggested waiting for strong confirmation rather than speculating on weak signals.
- Also, according to Dow, different indices (like the Industrial and Transportation averages) should confirm each other to validate a major trend.
Advantages of Technical Analysis
- Clear Entry and Exit Points: TA helps traders identify moments when a trend might begin or end.
- Comprehensive Market View: Charts bring together price, volume, and historical behavior, offering a holistic view.
- Objectivity: Price and volume are objective, measurable data. Unlike relying solely on news or fundamentals, chart patterns provide a more impartial way to analyze the market.
Drawbacks of Technical Analysis
- Subjectivity: Different analysts may interpret the same chart differently, leading to conflicting conclusions.
- No Guarantee of Accuracy: Because TA relies on historical data, past patterns don’t always repeat exactly.
- Lagging Nature: Trend reversals are often only apparent after they start; waiting for confirmation can be safer but may cost opportunity.
- Limited Fundamental Insight: Technical analysis largely ignores company fundamentals, macroeconomic shifts, and geopolitical news.
Don’t Doubt When Closing a CFD Trade
If you close a CFD trade based on technical analysis, avoid second-guessing yourself. The markets constantly change, and new opportunities always emerge. Some of the most successful CFD trades are those executed decisively - without letting doubt creep in.
We wish you a successful trading week on the Change App - trade with clarity, discipline, and a plan.
Until next week!
