In our previous sessions, we explored the fundamental analysis of digital assets. Now, we shift our focus to technical analysis, covering its core principles, common methodologies, and a brief introduction to futures contracts over the next three lessons. Both fundamental and technical analyses are crucial; very few investors succeed relying solely on fundamentals. Learning the basic principles and techniques of technical analysis is essential for making informed decisions.
This lesson introduces the foundational theories of technical analysis and several widely used technical tools in the market.
When technical analysis first emerged, it was often dismissed by fundamental analysts as mere astrology. However, from simple柜台报价单 to today’s electronic trading platforms, and from the 18th-century Japanese candlestick charts to modern quantitative strategies, the methods and forms of technical analysis have continuously evolved. Its widespread adoption stems from one simple fact: it helps users profit in the markets.
While fundamental analysis helps identify promising projects and predict long-term price targets, it often falls short in explaining short-term price fluctuations. Technical analysis, on the other hand, excels in identifying medium to short-term market trends. Although its analysis周期 is shorter, it offers higher precision in timing and direction. Each approach has its strengths and weaknesses, and a balanced understanding of both is advisable.
The Three Basic Assumptions of Technical Analysis
These assumptions form the theoretical foundation of technical analysis.
- Market Action Discounts Everything: Every factor that influences prices—be it fundamentals, political events, or psychological factors—is ultimately reflected in buying and selling activity, which determines price.
This is a cornerstone for pure technical analysts. All influencing factors eventually affect investors' decisions to buy or sell, resulting in a price that represents a temporary consensus or equilibrium among all market participants. This balance holds until new factors emerge to disrupt it.
- Prices Move in Trends: Once a trend is established, it tends to continue in the same direction.
This principle is a boon for trend traders. Prices move in the direction of least resistance, whether upward or downward, helping investors make informed directional choices.
- History Tends to Repeat Itself: Technical analysis is intertwined with market behavior and human psychology. Specific chart patterns often reappear, reflecting consistent human emotions like optimism or pessimism.
The legendary trader Jesse Livermore once said, “Wall Street never changes, the pockets change, the suckers change, the stocks change, but Wall Street never changes, because human nature never changes.” This repetition is less about price patterns and more about the unchanging nature of human greed and fear, which drive market cycles century after century.
Dow Theory
Considered the birthplace of technical analysis, Dow Theory uses price averages to identify market trends and conditions, helping predict future price movements. It classifies market movements into three types: primary trends, secondary trends, and minor trends.
- Primary Trend: Lasts a year or more, with most assets moving in the same direction, typically by over 20%.
- Secondary Trend: Acts as a correction to the primary trend, often deceptive, lasting over three weeks, and retracing one-third to two-thirds of the primary move.
- Minor Trend: Reflects short-term price fluctuations, usually lasting less than six days.
Generally, primary trends are predictable, while minor trends are largely random. Thus, focusing on longer timeframes can make directional analysis easier.
A bull market typically consists of three upward waves (similar to impulse waves 1, 3, and 5 in wave theory) interrupted by two downward corrections (waves 2 and 4). In a full market cycle, the final decline often exceeds expectations, and both upward and downward trends are rarely smooth, interrupted by several secondary corrections.
Gann Theory
Gann Theory posits that markets follow natural laws, and price movements are not random but predictable through mathematical methods. It aims to impose order on seemingly chaotic markets, identifying when prices will reverse and to what levels.
In practice, predicting exact price movements is notoriously difficult, which limits the popularity of Gann Theory. However, it still offers valuable insights.
For instance, Gann identified three common causes of trading losses:
- Overtrading with limited capital.
- Failing to set stop-loss orders to control losses.
- Lack of market knowledge.
These points align closely with the principles discussed in our second lesson on investment basics and common pitfalls.
Gann also developed several tools and rules, such as:
- Gann Angles: Combining price and time using geometric shapes like circles, squares, and hexagons.
- Retracement Levels: Key percentages like 50%, 63%, and 100% often act as strong support or resistance, correlating with angles like 45°, 63°, and 90°.
For more details, you can explore Gann’s 21 Rules, 12 Trading Principles, and theories on market cycles and geometric proportions.
Elliott Wave Theory
Developed by Ralph Nelson Elliott, this theory uses the Dow Jones Industrial Average to analyze market cycles. It suggests that markets move in repetitive patterns, each consisting of five impulsive waves followed by three corrective waves.
The eight waves are labeled: 1, 2, 3, 4, 5, A, B, and C. Waves 1-5 form the impulsive phase, with waves 1, 3, and 5 driving the trend and waves 2 and 4 correcting it. Waves A-C form the corrective phase, with A and C driving the decline and B offering a temporary rebound.
Key principles include:
- A full cycle has eight waves: five up, three down.
- Wave 3 is never the shortest among waves 1, 3, and 5.
- Wave 2 often retraces deeply but never 100% of Wave 1.
- Wave 4 should not overlap the price territory of Wave 1.
- Common retracement ratios are 0.382, 0.5, and 0.618.
- The theory reflects mass psychology and works best for broad market indices or highly liquid assets.
These rules help identify wave structures, but interpreting them can be subjective, leading to multiple valid counts (“thousand people, thousand waves”). This complexity has limited its widespread adoption.
Chan Theory
Emerging in the early 2000s, Chan Theory applies primarily to stock markets, blending traditional technical analysis with philosophical insights. Its creator, known as Chan Zhongshu Chan, gained fame through a blog series titled “Teaching You to Trade Stocks.” Unfortunately, he passed away in 2008 before formalizing his ideas into a book, leaving followers to compile his teachings.
Chan Theory refines traditional technical analysis by defining price movements through geometric concepts like fractals, strokes, segments, and central equilibrium zones. It aims to bring structure to seemingly chaotic price action.
For a deeper dive, you can refer to the compiled “108 Lessons of Chan Zhongshu Chan.”
Conclusion
At its surface, technical analysis studies price charts; at its core, it analyzes human nature. Human tendencies rarely change, and investor behavior driven by greed and fear follows predictable patterns. From the 17th-century tulip mania to modern speculative bubbles, the underlying logic remains identical.
This lesson covered the basic theories of technical analysis. In practice, numerous technical indicators help traders make decisions. 👉 Explore advanced analytical tools to enhance your strategy. Our next lesson, “A Guide to Technical Indicators,” will delve into these practical tools.
Frequently Asked Questions
What is the main difference between fundamental and technical analysis?
Fundamental analysis evaluates intrinsic value based on economic, financial, and qualitative factors, ideal for long-term forecasts. Technical analysis focuses on historical price and volume data to predict short-to-medium-term movements, making it better for timing entries and exits.
Can technical analysis be used alone for trading decisions?
While some traders use technical analysis exclusively, combining it with fundamental insights often yields better results. Technical analysis helps with timing, but fundamentals provide context about an asset’s long-term potential.
Why do historical patterns repeat in markets?
Market patterns repeat due to consistent human psychology. Emotions like greed during rallies and fear during sell-offs create cyclical behavior, making historical data a useful guide for future movements.
How reliable are trend predictions based on technical analysis?
No method guarantees 100% accuracy. Technical analysis improves probability but requires risk management tools like stop-loss orders. Trends can change unexpectedly due to external events, so flexibility is key.
What is the best timeframe for technical analysis?
It depends on your trading style. Day traders use short timeframes (minutes/hours), swing traders medium timeframes (days/weeks), and long-term investors focus on weekly or monthly charts. Aligning the timeframe with your goals is crucial.
Do I need complex tools to start technical analysis?
No. Beginners can start with basic tools like moving averages, support/resistance levels, and candlestick patterns. As you gain experience, you can explore advanced indicators and theories.