Let’s discuss Technical Analysis to begin with.
I’m not going to repeat the actual definition of the term “technical analysis”. Its out there and easy to find. What I do want to discuss is the nature of trade that is being taken on the basis of “technical analysis” or after studying the charts of any instrument.
The trades based on technical analysis are nothing but follow up trades to some event(s) that has happened in recent past, either individually for the company or the market as a whole. For e.g. when a stock opens for trading on the first day after its IPO has no past history of price movement (at least in the open market) that can be plotted on a chart. So there cannot be any candlesticks or technical indicators like MACD, Bollinger Bands, Moving Averages, etc to look at.
Market forces will decide whether to take the price higher or lower based on its demand, company financials, industry outlook and so forth. Once we have few candles, only then can we start to look at price action movement of previous candle(s), and apply technical analysis of any sort.
The trades that move the price itself (and consequentially the indicators) are mostly driven by fundamental analysis, market sentiments, news or institutional/large investors deciding to move in or out of the stock. For e.g. a great quarterly result from a company gives the market a signal to buy the stock even if the current price action or indicators might have a negative setup. It doesn’t matter even if the trend is down. The fundamentals (in this case a good quarterly result) will take the price higher, thus aiding all the indicators to start changing from negative outlook to a positive one. In technical jargon it would indicate a trend reversal.
On the other hand, if a trader takes a trade not based on any fundamental or market driven event, or without doing any technical analysis would just be a speculative trade… a gamble! For instance suppose a stock has risen a lot compared to its earlier price action and now you just “believe” that it has to fall down to revert back to one of its averages (mean reversion). Unless the price movement factually shows a breakdown in price that results in the indicator(s) turning negative, the trade to short that stock will be a purely speculative one, which means its probability of winning will be half or just 50%.
What technical analysis does is it provides a way to recognize repetitive patterns of price action (candlestick types) or indicators (MACD converging and diverging as an example) and increase the probability higher than 50% based on correct recognition of that pattern’s re-occurrence, thus giving a trader a factual base to rely on more than a speculation or belief. It goes without saying that predicting a move in a financial or stock market can never be assured with certainty. However, coupled with back-tested results over a substantial period of time and sensible risk management rules, technical analysis becomes a practical framework to research, analyze, and trade with discipline.