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Technical analysis can be defined as the study of historical price movements in an effort to forecast future price movements with the primary tool for technicians, as they are often referred to as, being the price chart. Technical analysis is applicable to all securities such as stocks, futures, commodities, indices, and currencies where the price is influenced by the forces of supply and demand.
The history of technical analysis stems from the Dow Theory which was developed in the early 1900s by Charles Dow. The main principles of the theory include: 1) price discounts all known information, 2) price movements follow trends and are not completely random, and 3) history repeats itself. A direct consequence of the Dow Theory is the widely followed Dow Jones Industrial Average.
Technical analysts believe that the current price fully reflects all available information. Because all information is already reflected in the price, it represents the fair value and should form the basis for analysis.
Technicians believe that the markets may experience extended periods of random fluctuation whereby the price is unpredictable but most technicians would also agree that there exists shorter periods of non-random price movements that can be analyzed and forecasts can be derived. Technicians believe that it is possible to recognize a trending market, invest or trade based on the trend, and come out on top as the trend unfolds. Because technical analysis can be applied to many different timeframes, as explained in the Chart Analysis section, it is possible to spot both short-term and long-term trends.
In general, technical analysis is performed by comparing the current price action of a security with its historical price action to predict future movements. It follows then that this process can be defined as the fact that history repeats itself.
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