Technical trading: how traders predict price movements

Why is technical analysis essential for traders?

For those who operate in financial markets, understanding historical price and volume fluctuations is key. Technical analysis is a methodology that uses past data to anticipate where the market will go, allowing the identification of potentially profitable entry and exit points.

Unlike fundamental analysis, which examines a company's financial health, technical analysis focuses on the pure behavior of price and chart patterns. This makes it especially useful for traders looking to take advantage of short-term movements.

Origins and evolution of technical analysis

Although there are primitive records in Amsterdam during the 17th century and in Japan in the 18th, the modern structure comes from the work of Charles Dow. This financial journalist observed that markets move in predictable and segmentable trends, laying the foundation of Dow Theory.

The interesting thing is that, in its beginnings, everything was done manually with sheets and rudimentary calculations. Today, with computational technology, technical analysis has become an indispensable tool for professional investors and retail traders.

The logic behind price movements

Technical analysis is based on a fundamental premise: all available information is already incorporated into the current price. Therefore, by observing historical patterns and volumes, it is possible to project future movements.

Essentially, analyzing prices is understanding the battle between supply and demand. The price reflects the opposing forces of buyers and sellers, forces that are directly linked to the emotions of fear and greed that drive the decisions of traders and investors.

It is important to highlight that technical analysis works best in markets with high volume and liquidity. These markets are less vulnerable to manipulations and anomalous movements that would generate false signals.

Technical Indicators: Key Tools for the Trader

Moving Averages: Identifying Trends

Moving averages are essential indicators for any trader. There are two main types:

• Simple Moving Average (SMA): averages the price over a specific period, smoothing out short-term fluctuations.
• Exponential Moving Average (EMA): gives more weight to recent prices, making it more sensitive to new data.

These indicators help to detect the direction of the trend and levels of support and resistance. A popular strategy involves watching when the short-term moving average crosses the long-term moving average, generating potential buy or sell signals.

RSI: measure the momentum

The Relative Strength Index (RSI) is an oscillator that measures the rate of change on a scale from 0 to 100. Traditionally, an RSI above 70 indicates that the asset is overbought, while below 30 suggests oversold.

MACD: trend following

The MACD (Moving Average Convergence/Divergence) is an indicator that tracks the relationship between two moving averages. It includes the MACD line, the signal line, and a histogram, being useful for identifying potential entry and exit points.

Bollinger Bands: real-time volatility

Bollinger Bands measure market volatility by using two bands that surround a moving average. They are particularly useful for detecting overbought or oversold conditions.

Generating practical trading signals

The indicators not only reveal trends but also generate specific signals:

• Overbought/Oversold: the RSI can alert when to sell ( overbought asset ) or buy ( oversold asset )
• Moving Average Crossovers: the golden cross (short above the long) signals potential bullishness, while the death cross (opposite cross) suggests bearish pressure.
• MACD Signals: when the MACD line crosses above the signal line, it may indicate bullish momentum; the opposite suggests weakness.

However, it is crucial to remember that these signals are not always accurate. Especially in very short-term trades or illiquid markets, indicators can produce false signals. For this reason, combining them with risk management and other analysis methodologies is essential.

Weaknesses and Criticisms of Technical Analysis

Technical analysis faces valid criticisms that every trader must consider:

• Self-fulfilling prophecy: some argue that it works simply because many traders use the same indicators, creating predictable results for that very reason.
• Interpretive subjectivity: different operators may reach different conclusions about the same chart.
• Vulnerability to anomalies: during high volatility or unforeseen events, technical analysis may fail

Despite these limitations, most professionals find value in this tool, especially when combined with other forms of analysis.

Technical analysis vs. fundamental analysis: which to choose?

These two approaches have different purposes. Technical analysis is geared towards short-term trades, helping to optimize entry and exit points. Fundamental analysis, on the other hand, evaluates the real value of an asset through financial statements and economic indicators, being more appropriate for medium to long-term investment decisions.

Many experienced traders combine both methods: they use fundamental analysis to choose which assets to include in their portfolio and technical analysis to determine when to trade them.

Final reflection

There is no single definitive method to predict price movements. Although technical analysis is controversial and has limitations, it remains valuable for traders looking to benefit from short-term movements. Fundamental analysis, on the other hand, provides a solid foundation for long-term decisions.

The key is to understand that technical analysis complements, not replaces, other strategies. A well-prepared trader uses technical indicators along with disciplined risk management and multifactorial analysis to make more informed decisions in the markets.