Technical Analysis - Fundamental Analysis - Technical Indicators
Technical Analysis vs. Fundamental Analysis
While the market's function is price discovery, an analyst's function is price forecasting in order to make profitable trades. There are two basic approaches to market analysis -- technical analysis (of market data) and fundamental analysis (of market environment).
Technical analysis is a method to forecast price movements of individual commodities and/or entire markets by looking at purely market-generated statistics abstract summaries of price activity. One tenet of technical analysis is that all market fundamentals are depicted in the actual market data. Thus actual market fundamentals and various unquantifiable meta factors, such as the differing opinions, hopes, fears, and moods of market participants, need not be studied.
Another area of interest is that history repeats itself, such that markets move in fairly predictable, or at least quantifiable, patterns. These patterns, generated by price movement, are called signals. The goal in technical analysis is to uncover the current market's signals by examining past market signals.
Prices move in trends. Technicians typically do not believe that price fluctuations are random and unpredictable. (Most reject the weak-form explanation of market efficiency and dismiss the random walk theory.) Prices can move in one of three directions, up, down or sideways. Once a trend in any of these directions is in effect it usually will persist. The market trend is simply the direction of market prices, a concept which is absolutely essential to the success of technical analysis. Identifying trends is quite simple; a price chart will usually indicate the prevailing trend as characterized by a series of waves with obvious peaks and troughs. It is the direction of these peaks and troughs that constitutes the market trend. Technical analysis attempts to determine the strength and direction of the trend and the change in the trend direction.
The building blocks of any technical analysis system include price charts and technical indicators, which are merely mathematical representations of market patterns and behaviors. (Other types of technical indicators, such as sentiment or flow of funds, have limited value in commodity trading.) Forecasting models usually include at least one type of indicator in relation to a particular type of price chart and look for divergence or continuity between indicators and price to determine the validity of a trend. Let's examine some of the types of indicators used in technical analysis:
Commodity / Futures Price Chart Patterns and Indicators:
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Chart patterns are hills and valleys, shapes and curves that develop over time on a chart which often indicate changes in price direction.
Like bar charts patterns, candlestick patterns can be used to forecast the market. Because of their colored bodies, candlesticks visually represent greater detail in their chart patterns than bar charts.
Point and figure patterns are essentially the same patterns found in bar charts but transposed on charts with no time scale.
Trend indicators smooth variable price data to create a composite of market direction.
Market strength indicators describe the intensity of market opinion with reference to a price by examining the market positions taken by various market participants.
Volatility indicators describe the size of day-to-day price fluctuations independent of their direction.
Cycle indicators determine the timing of a particular market patterns.
Support and resistance indicators describe the price levels where markets repeatedly reverse.
Momentum indicators determine the latent strength or weakness of a trend as it progresses over time.
Trading and Analysis
“Technical and fundamental signals often conflict with each other. There are times when the charts signal one direction and fundamentals scream another. An investor with knowledge of both can effectively enhance a portfolio by understanding commodity fundamentals and by using technical signals to get into or out of investment positions.” - Andy Hecht, How to Make Money with Commodities
You have created your trading plan and thought through a money management strategy that works best for you. Now it’s time to define how you plan to make buy and sell decisions.
•What type of trader you are going to be?
•What type of tools or analysis will help you achieve your personal goals?
Some traders and investors like to look at price patterns on a chart and technical indicators to make a decision, i.e., technical analysis. Some prefer to back up their decisions with news and data, i.e., fundamental analysis. Still others combine these two techniques.
Many traders attempt to combine technical and fundamental analysis to derive a benefit from both approaches, each with their own virtues and drawbacks. Whether you choose to employ fundamentals, technicals or both to help predict the future, always remember that the current market price is always the right price. The market always knows best because the latest price is the one at which current sellers and current buyers are meeting in a fair and transparent marketplace.
In this section, you’ll explore the differences between fundamental analysis and technical analysis. Then, you’ll learn an important concept that traders need to understand—the difference between trending and anti-trending markets.
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