How well does technical analysis work?


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Many CFD traders believe that technical analysis is the key to profiting with online trading and that mastering it is the most important aspect of learning to trade CFDs. Others see technical analysis as a fairly superficial obsession with patterns and charts that might not be necessary if the trader truly understands the market and how to use fundamental analysis.

More traditional traders, including those who come from a background of big business and traditional finance, may put more faith in fundamental analysis and be distrustful of market analysis based solely on technology. Even traders who start out believing in the importance of technical analysis may become discouraged if their initial experience does not live up to expectations. This is generally a mistake. Technical analysis does work, and many who think otherwise may simply need more training and education or better trading strategies.

Whether you use fundamental or technical analysis, it is vital to accept that analysis is only one step in your trading strategy. How you use that analysis and the decisions that you make based on it is where the heart of your trading strategy lies. Technical indicators are not meant to tell you exactly when to enter or exit a position, how much to invest or how conservative or aggressive to be in your trading activity. Technical indicators are just that: indicators of what is happening in the markets. Decisions on which trading strategies to use are still yours to make. Technical analysis informs your decisions by providing insights regarding patterns and trends. What you do with those insights is up to you.

In addition, any one technical indicator can give a false signal, so it is important to use more than one to provide a better overall picture of the markets. Many new traders or those new to technical analysis will learn how to use technical indicators one at a time. This is understandable and advisable, as it takes time to familiarise yourself with each tool. However, it is also what may cause newcomers to make mistakes and lose faith in the concept. You can learn technical indicators one at a time or in combination with one another to get a clearer and more accurate overview of the markets.

If you are trading CFDs, then technical analysis can help, but be aware that:

  • Technical indicators are tools that can aid you, not magic wands
  • Both technical and fundamental analysis are useful, and you can combine them
  • It takes time and effort to learn how to use different technical indicators
  • It takes more time and effort to learn and apply general technical analysis skills
  • Technical indicators give the most accurate feedback when combined
  • You still need to understand trading techniques and strategies
  • Technical indicators are not your trading strategy; they are something that you can use to shape your trading strategy
  • General education on strategy, money management and discipline are still important

Here are a few other related questions that new traders ask about technical analysis:

Do you have to be technologically savvy to use technical analysis?

These days, technical analysis has an association with apps and software, so it is easy to forget that it was around before computers were common and certainly before every trader carried a smartphone full of apps in his or her pocket. There are older, traditional traders who do not consider themselves particularly tech-savvy but who have been trading their whole lives routinely using technical analysis. Technical indicators do not require you to be any more technologically savvy than on the average. They do require you to learn how to read and monitor charts, data and figures, but this is more about being practical, numerate and data-oriented than technologically advanced.

Does technical analysis work better for day traders?

Technical indicators are common and well-respected in the world of day trading and are helpful for short-term traders in general, but it is a myth that this is the only way that they are useful. High-frequency traders will certainly benefit significantly from learning to use technical analysis, but long-term investors also use it. Many technical indicators are used by different traders across widely different time frames, with traders able to use their charts to monitor minute-by-minute changes, weekly changes or monthly changes in the markets.

Does technical analysis work better than fundamental analysis?

One of the myths around market analysis is that technical analysis can provide very accurate and precise price movement predictions, while fundamental analysis looks at “bigger picture” issues and is more “fuzzy.” This is not actually the case. The technical analysis measures trends and patterns and cannot predict an exact price rise or fall within a certain time frame. It can certainly give experienced traders an idea of the sort of range where the price of a stock or currency will be at a set point in the future, but it is not as accurate as many new traders assume. Do not get a false sense of security by all those charts and data points, as they are constantly changing.

Fundamental analysis looks at intrinsic value based on factors such as tangible assets, turnover, patents and intellectual property, which are hardly “fuzzy” concepts. In short, there is not a case of one being better than the other. They measure different things, and traders who are serious about their investments will find it beneficial to consider both.

Why does technical analysis not always work?

As already mentioned, a major reason why traders using technical analysis fail to make a profit is a lack of knowledge, training and education. They may not fully understand the indicator that they are using or simply make bad decisions despite good data. There are also various reasons why technical indicators can give false signals. Being aware of why this happens can help traders spot the signs and avoid a false signal tripping them up. False signals are another reason why it is beneficial to use multiple indicators to monitor the markets.

 

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