In this article, you will learn the three fundamental principles of technical analysis.
1st Principle – Market discounts everything.
Everything includes news, facts, data, emotions, and expectations. Everyone (including the fundamental analyst) ponders over each piece of information to make only one decision: to buy or to sell. This single decision affects price and volume.
And what everyone is really interested in is the price. The price tells us if we are in the green or red. As market prices fluctuate, your net asset value fluctuates. This is how important the market is. Hence,
Hence, price and volume are all we need. This simplicity is what I like about technical analysis.
2nd Principle – Market has inertia.
If the market is rising, it will more likely continue to rise. If the market is falling, it will more likely continue to fall. If the market is not going anywhere, it will more likely continue to stay within a range.
These observations are vital to traders as our edge lies in staying with the inertia.
Hence, in technical analysis, we have this saying: “the trend is your friend”.
Now, close your eyes and pick a random point on a chart. Repeat it 100 times.
How many times have you picked the exact turning point of a trend?
Any answer more than zero is impressive. This shows how important it is to stay with the trend.
3rd Principle – Market moves in waves.
The market does have an unknown target price determined by fundamentals (or rather what we expect of it). As information keeps changing, the market has a moving target.
However, it does not move in a straight line directly to the price target.
This is because traders operating in different time frames have different needs. As a result, demand may exceed supply at this moment, and supply may overcome demand in the next.
This imbalance causes prices to move in ebbs and flows. In using technical analysis, this is a crucial principle as we use these ebbs and flows to time our entries and exit in line with the inertia.
(Learn more about Technical Analysis with the Chartered Market Technician Program.)