Practical Guide to Technical Analysis: From Theory to Action

The Essentials You Need to Know

Technical analysis is the tool used by traders and investors to read the market through price charts and volume information. Instead of analyzing financial statements or business news, this method focuses on recognizing patterns and trends in historical price data.

Three key points of technical analysis:

• Identify entry and exit opportunities through patterns and price levels
• It is based on supports, resistances, and indicators such as RSI, MACD, Bollinger Bands, and moving averages.
• Requires cross-confirmation and risk management to avoid false signals, especially in volatile or low liquidity markets.

Trading Signals: The Trader's Compass

For most traders, what really matters is turning analysis into concrete decisions. Trading signals are exactly that: indicators that suggest when to act.

The main signals include:

• Overbought and oversold: When the RSI rises above 70, the asset is overbought (potential sell signal). Below 30 indicates oversold (potential buy signal).
• Moving Average Crosses: The golden cross (short moving average crosses above the long )is bullish. The death cross (the opposite )is bearish.
• MACD Signals: When the MACD line crosses above the signal line, it may indicate a bullish trend; below, a bearish trend.

However, this is not infallible. In low time frames and illiquid markets, these signals generate a lot of noise (false positives). That's why you should never rely on a single signal.

Most Used Technical Indicators

Traders use various instruments to analyze price behavior. The most popular are:

Moving Averages (MA)

There are two main types:

• Simple Moving Average (SMA): Averages the price over a specific period, smoothing out minor fluctuations.
• Exponential Moving Average (EMA): Gives more weight to recent prices, reacting faster to new changes.

Moving averages work by identifying the direction of the overall trend. When you see the short average crossing above the long one, it is a potential buying point.

Relative Strength Index (RSI)

The RSI is an oscillator that measures the speed of price change on a scale of 0 to 100. Its interpretation is straightforward:

• RSI > 70 = Overbought (possible bearish correction)
• RSI < 30 = Oversold (possible bullish rebound)

This indicator is especially useful in sideways or ranging markets.

Bollinger Bands (BB)

They consist of two bands that surround a central moving average. Their usefulness lies in measuring volatility:

• When bands expand, there is greater volatility
• When they contract, the market is calm and strong movement could come.
• If the price touches the upper band, it could be overbought; at the lower band, oversold.

Moving Average Convergence/Divergence (MACD)

The MACD combines two exponential moving averages and generates three components: the MACD line, the signal line, and a histogram. When these elements interact, they provide trend change signals.

Fundamentals: How Technical Analysis Works

The main premise is that all known information is already reflected in the current price. This means that by studying historical patterns and volumes, you can anticipate future movements.

At its core, technical analysis is the study of supply and demand forces. The price is a battle: buyers push up, sellers push down. These forces are completely tied to the fear and greed of traders.

A critical aspect: technical analysis works best in markets with high volume and liquidity. Thick markets are more resistant to manipulation and less likely to generate false signals derived from abnormal external events.

History of Technical Analysis

Although there is evidence of primitive techniques in Amsterdam (seventeenth century) and Japan (eighteenth century), modern technical analysis was born with Charles Dow, financial journalist and founder of The Wall Street Journal.

Dow was one of the first to observe that markets move in identifiable and analyzable trends. His legacy is Dow Theory, which laid the groundwork for everything that came after.

Initially, this was done with sheets of paper and manual calculations. With modern computing, technical analysis became democratized and is now essential for millions of traders.

The Legitimate Criticisms of Technical Analysis

Technical analysis has its detractors, and some criticisms carry weight:

Self-fulfilling prophecy: Some argue that it works simply because many traders use the same indicators, creating predictable outcomes by consensus.

Subjectivity: Two traders can interpret the same chart in completely different ways, reaching opposite conclusions.

Ineffectiveness in Anomalies: During unexpected events, extreme volatility, or abnormal market situations, technical analysis may completely fail.

Counterpoint: Defenders argue that each trader has their own style of reading charts, making it impossible for a large number to follow exactly the same strategy.

Despite the criticism, many traders find real value in these tools, especially when combined with other methods.

Technical Analysis versus Fundamental Analysis: Two Approaches, Two Horizons

Here is the essential difference:

• Technical Analysis (AT): Look at charts, patterns, and historical numbers. It is ideal for short-term trading.
• Fundamental Analysis (AF): Examines financial statements, economic indicators, business health. Best for long-term investments.

In practice, many successful investors use both. Fundamental analysis tells you what to buy; technical analysis tells you when to buy it.

The Balanced Strategy

The consensus among professionals is that combining both approaches is the most prudent.

Fundamental analysis gives you confidence in the asset for the long term. Technical analysis helps you identify the best times to enter, exit, or adjust positions in the short term.

While some traders live off scalping and need pure technical analysis, investors with a multi-year horizon can rely more on fundamentals. Most, however, benefit from using both lenses.

Final Considerations

Technical analysis is not a crystal ball. It is a tool that improves your odds when used correctly. Remember:

• False signals are inevitable, especially in small or volatile markets.
• Always apply risk management; never rely on a single indicator
• Cross confirmation ( using multiple indicators or methods ) significantly reduces errors
• Combine with fundamental analysis for stronger decisions

Technical analysis has proven to be valuable for almost 400 years because it reflects a simple principle: markets move in patterns, and those patterns can be studied. However, it requires discipline, practice, and humility to recognize its limitations.

Note: This content is informational and educational. It does not constitute financial, legal or investment advice. Trading decisions are solely your responsibility. All markets carry risk, including total loss of invested capital.