History and principles of technical analysis


There are several methods of financial analysis used to predict market movements, the two most commonly used are fundamental analysis and technical analysis.

Different theories of analysis can be seen as pieces of a puzzle whose combination can lead us to predict the direction of the market with the greatest probability of success.

The roots of modern technical analysis lie in the Dow Theory, developed by Charles H. Dow (1851-1902). His philosophy on markets, price action analysis, and other techniques have been used ever since, and even today the basic components of the Dow Theory remain useful.

Robert Rhea is another great figure in the history of technical analysis with his extensive statistical market studies and he was the first technical analyst who defined the minimum range that divergence should have to be considered as a secondary movement defined in Dow theory (not be discouraged if the story bores you, skip it).

Richard Schabacker (1902-1938) is considered the Father of modern technical analysis for classifying the tools to aid technical analysis, not only for predicting future movements in the markets but also for predicting the end of the prevailing trends. He was the first to classify common chart patterns today, developed the theory of price gaps, formalized the use of trend lines, and tested the importance of support and resistance levels.

Among the most popular tools developed by Richard Schabacker are bar charts.

Richard Wyckoff , another monster of technical analysis, his work was in the development of a methodology focused on the logic behind the market using the market volume or indexes composed of instruments of the market itself to predict trend changes in the earliest stages.

The next big step was the Elliot Wave Theory, proposed in the 1930s by RN Elliot (1871-1948).

The Principles of Technical Analysis

There are 3 sources of information for technical analysis: Price, Volume and Open Interest (the latter only for futures contracts). The 3 fundamental principles of technical analysis are as follows:

  • Price is everything. The price is affected by economic, political and social factors, all this information being reflected in it. Technical analysis uses the information captured by price to interpret what the market is saying for the purpose of forming a vision for the future.
  • Price movements are not random. The main purpose of charts is to define a trend at an early stage in order to trade according to its direction.
  • History repeats itself. Techniques that were effective in the past may still be effective as prediction tools.

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