Technical analysis is focused on price behaviors based on an existing fundamental
scenario. Most investors regard technical analysis as voodoo, a technique based
on non-sense array of lines and randomly generated numbers. This conclusion
is in fact unfair. Somehow, all traders used technical analysis on its most
basic form, by looking at line charts and assessing the current trend of the
security. This method has been around for over 100 years, and it is a direct
result of numerous observation of price behavior that spanned major booms and
Prices of securities are not exclusively powered by their balance sheets, and
currencies are not controlled by its country's current economic state but rather
dictated by the forces of human emotion. For instance, you may find it confusing
as to why the US dollar is rising in value against other currencies while its
economy is in a deep recession. However, if psychology is tapped to find answers,
you will most likely find it. It doesn't require a good sounding balance sheet
for a stock price to rise, even a badly damaged boat would rise if the tides
are high. This means markets are grouped together as a herd, and behave that
way too. If one yells "fire" in a crowded room, without second thought
since their life is at risk, everybody would try to exit the room without first
confirming that the building is in fact on fire.
Markets are always right in terms
of price, but we cannot say whether or not a recent move was based on rational
decisions. Notice the fact that the market is composed of numerous traders having
positions on both directions. One trader's gain is another's loss, so putting
this in the picture, prices would retrace or reverse temporarily before resuming
its long term trend. A retracement occurs because of human emotion at work.
When you are very mad, you cannot tolerate being angry for an extended period
of time, in some way, your emotions would go back to your normal level. If a
trader buys a security or a currency, it is very imminent that he or she will
sell it at some point for profit or an intolerable loss. This is the reason
why trends tend to pull back before continuing its direction if not completely
reverse. Technical analysis cannot be used to guarantee pending price movements.
Nobody knows for sure what happens next, but technical trading provides high
probability forecasts which can be used to generate bigger gains than losses
if used properly.
No system is perfect, just like how the weather man is not at all 100% right.
Technical analysis is a great forecasting tool when paired with fundamentals,
but its final result depends on the assumptions of the trader. Expecting a 100%
win ratio is too far fetched for trading securities or currencies, accepting
losses is a part of it. Just think of a restaurant business, it has to spend
money on rent and other equipment to make a profit, but some days are just slow
and costs at most times outweight profit.