The 3 Basic Components of Technical Analysis

Apurva Sheth
Last time I ended with this quote - "Our youth now love luxury. They have bad manners, contempt for authority; they show disrespect for their elders and love chatter in place of exercise; they no longer rise when elders enter the room; they contradict their parents, chatter before company; gobble up their food and tyrannize their teachers."

I am sure each one of you must have come across similar lines at one point or other.

Those of you who have grown-up children may have said the same things to them. Our grandparents may have similar opinion about today's generation. But have you ever wondered when this statement was first recorded?

Any guesses on the year?

No, it's not today... and not even 20 years back. You have to go back very far away in history to trace it. It is 2,400 years ago that the great philosopher Socrates (469 BC-399 BC) made this statement.

Amazed, perplexed, bemused, shocked?

I'm sure you are.

But that's the way it is. Human nature and emotions remain the same irrespective of the era one is in.

People were greedy and fearful even a hundred years back as much as they are now.

These emotions have ruled mankind ever since the first human walked on this earth and will remain so until the last person alive. People always tend to react in a similar fashion. It is this similarity that leads to the formation of identifiable price patterns over and over again (See I told you it leads to technicals!).

Technicians have developed descriptions of emotional patterns that are reflected in price action that tends to repeat over time. (If this weren't true, all technical analysts and charting service providers would have been out of business long back.)

If I were to sum up this aspect, "history repeats itself" is what comes to my mind. It is the first basic premise of Technical Analysis.

Second is "market action discounts everything".

This means anything that can possibly affect the price fundamentally, politically, psychologically, or otherwise - is actually reflected in the current price. A study of price action reflects all the shifts in supply and demand. If demand exceeds supply, prices should rise. If supply exceeds demand, prices should fall. This action is the basis of all economic and fundamental forecasting.

A technician then turns this statement around to arrive at a conclusion that if prices are rising, for whatever specific reasons, demand must exceed supply and fundamentals must be bullish. If prices fall, then fundamentals must be bearish.

The third premise is that "prices move in trends". The whole purpose of charting price action is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. A trend once established will continue in the same direction until it reverses.

Now having understood the basic premise of TA, let me just show you in a simplistic format what TA is comprised of. The picture below shows three subjects that combine to form Technical Analysis.

Components of Technical Analysis
Source: Profit Hunter

It's an easy trick to tell whether you would like TA or not.

If you liked all the three fields at school or college then you would like TA as well. But don't worry if you were bad at any of these. I was bad in geometry at school but still fared well at TA (in our journey I will tell you all about my successes and, more importantly, failures). You can also develop a liking for the subject if you are willing to learn.

The most important component of all is Psychology. It strives to find answers to why people feel, think and act the way they do.

I had explained how a simple transaction of buying groceries takes place in a previous article. We know that the degree by which buyers and sellers decide to raise or lower their prices, directly affects the transaction price. Wouldn't it be a plus if we could tell which side is in a better position to hold command over the prices? Such an observation would reveal a lot about the anticipated price shifts. And that's what we are concerned about in Technical Analysis.

The process of plotting trendlines, identifying chart patterns and naming them such as rectangles and triangles draws the link between technical analysis and geometry.

A technical indicator is actually a mathematical formula that is first computed and then plotted on a chart. Moving Averages are the simplest form of indicators which are derived mathematically. Other methods like projecting targets from a pattern, computing Fibonacci projections and retracements are all form of mathematical calculations.

I think by now you must be clear how all three are inter-related and how they apply to TA.

Now that you have thoroughly understood the philosophy behind technical analysis, I'm sure all of you are keen to see how it actually works.

We will go live in action as soon as our next article. I will start with basics of charting and introduce you to various types of charts and their application.

Until then do share your views and feedback on the articles you have read so far.

Did they help you improve your understanding of Technical Analysis? Share your views in the Club or share your comments here.

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18 Responses to "The 3 Basic Components of Technical Analysis"
joginder pal
17 Sep, 2016
This is bit more technical, but it has certainly improved my understanding of technical analysis. Hope to learn more from your next articles. Thank youLike 
H.L.PATEL
01 Dec, 2015
Very simple to understand 3 basic subjects of TA explained in your article. I expect more information in next upcoming articles. All the best for future articles. Like 
Mathew
15 Dec, 2014
well informed.InterestedLike (2)
Venkat Rao
13 Dec, 2014
Well informed. I am very eager to learn TA. Please go forward.Like 
Gaurang
09 Dec, 2014
Good One, So simple to understand. m also want to learn TA in deep. pls let me know for this. Like 
P. A. Kishore
06 Dec, 2014
I agree you have outlined the things regarding TA very succinctly and look forward for your upcoming articles which I expect to be similarly lucid. As regards your quote, which turned out to be of Socrates, I would like to point out that some Chinese philosopher, like Confucius or his contemporary, had also commented on similar lines and my hunch, as expressed in my comment dated 30.11.2014, regarding repetition of history and its leading to TA was not far from the bull's eye.Like 
Pradeep
05 Dec, 2014
Superb article... I read the first one from tht i am wiating for this one and now for next one..... Language IS SO SIMPLE AND EASY TO UNDERSTAND .....Like (1)
Chandravadan
04 Dec, 2014
Super article on TA, excited to know more..thanksLike 
Dhawal
03 Dec, 2014
Great start. Excited to read next article. Like 
rampal singh
03 Dec, 2014
Good explanation of technical analysis. looking forward to next in series...Like (1)
Madhu Sudan
03 Dec, 2014
A very good elaboration.Like 
Raviraj
03 Dec, 2014
Hi Apurva, Nice article on TA and hope to see more on TA. TA is more reading human psychology on charts and the same patterns repeat again and again. There are few recurring patterns whose probability is more.Like 
v.r.sekar
03 Dec, 2014
Indeed its true. I wish him to come out more lessons to share traders as well as others. It is very useful. pl. continue.Like 
Subramanian Ram
03 Dec, 2014
Excellent analysis & reading stuff. Still it is the human beings who are prone to excessive emotions and who can easily be swayed into taking wrong decsions when they are emotionally involved, take the call on when to enter and exit the market. This decision can easily backfire as too much of emotional involvement clouds the judgement. Asad Dossani will definetly vouch for the fact that trading decsions with a detached mind has a better chance of success. That is the reason system generated trades without any human intervention is becoming increasingly popular. Could you suggest a trading plan which has greater chances of success which involves application of technical studies ?Like 
Lenin C
03 Dec, 2014
Really simple and educative with lucid language. We look forward these kind of articles as frequently as possibleLike 
rashmikant Shah
03 Dec, 2014
I fully endorse your views and I have experienced too.Like 
Ramaswamy Iyer
03 Dec, 2014
I do not agree with the statement that if prices are rising / falling, fundamentals must be bullish / bearish. From my observation of the markets, prices can stay divorced from fundamentals for long but not too long (tech stocks like Amazon are excluded from this statement!). As Benjamin Graham put it so succinctly "in the short run, the market is a voting machine but in the long run, it is a weighing machine.' Like (1)
Amit shah
03 Dec, 2014
Good one.Like 
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