Philosophy of Technical Analysis

There are three premises on which the technical approach is based:

1. Market action discounts everything.

This is probably the cornerstone of technical analysis. The technician believes that anythig that can possibly affect the price–fundamentally, politically, psychologically, or otherwise–is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required. By studying price charts and a host of supporting technical indicators, the chartist in effect lets the market tell him or her which way it is most likely to go.

2. Prices move in trends.

The concept of trend is absolutely essential to the technical approach. The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends.

There is a corollary to the premise that prices move in trends–a trend in motion is more likely to continue than to reverse. A trend in motion will continue in the same direction until it reverses. The entire trend-following approach is predicated on riding an existing trend until it shows signs of reversing.

3. History repeats itself.

Much of the body of technical analysis and the study of market action has to do with the study of human psychology. Chartpatterns reflect certain pictures that appear on price charts. These pictures reveal the bullish or bearish psychology of the market. Since these patterns have worked well in the past, it is assumed that they will continue to work well in the future. They are based on the study of human psychology, which tends not to change. So, understanding the future lies in a study of the past.

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