Technical analysis combines various elements of research and analysis, and is used widely by traders and investors. Learn how to use technical analysis to help you develop a trading process tailored to your investment goals.
Viewing the trading process as distinct stages is a good way to improve your trading. A clear trading plan starts with researching the aspects of fundamental analysis that can help you to develop a strategy.
Secondly, technical analysis can be used to gauge market mood and help with ongoing trade management. Finally, post-trade reviews and strategy revision can be used to make improvements to your process moving forward.
What is the trading process?
The trading process explains the sequence of events that form the life of a trade. The different stages make intuitive sense, and working through them in order can help to instil discipline in your trading activity.
| Fundamental Analysis | Technical Analysis | Management | Review |
|---|---|---|---|
| Economic cycles | Trade entry points | Market conditions | Was your strategy successful? |
| News | Target prices | Position management | Did you stick to the plan? |
| Data mining | Stop-losses | News monitoring | Personal improvement |
| Trends | Risk management | Emotion management | Strategy improvement |
| Goal: What do you want to trade and why? | Goal: Optimise returns | Goal: Stick to your plan | Goal: Learn and repeat! |
How to create a fundamental & technical analysis trading strategy
Establishing the purpose of each of the four stages of a trade process draws on the key principles of investing. Although there can be some blurred lines between the different stages, following the outline will generally help you to get the most out of your trading.
Fundamental analysis
Fundamental analysis is used to form a view on whether an asset is currently overvalued or undervalued. It considers price drivers that are specific to a particular instrument, but also incorporates macroeconomic factors such as economic cycles and geopolitical events.
Tip: Your fundamental analysis should consider upcoming news events that might act as a catalyst and trigger future price moves.
Technical analysis
Once you have sufficient confidence in the direction that an asset’s price is likely to head, it is time to use technical analysis to optimise your trade entry and exit points. It can help you to spot trends, while price patterns and charting can be used to track the progress of your position and highlight ranges in which you can expect price to trade.
Tip: Technical analysis can pinpoint when market prices have moved away from long-term averages that denote the “normal” trading range.
Management
Effective trade management can potentially help you to enhance your returns. Adjusting position size can help to manage risk or scale up on returns. Trading involves more than just making the right call; it is important that you ensure that profits on winning trades counterbalance the inevitable losses on unsuccessful trades.
News events should also be taken into consideration, and while the aim is to stick with your plan, there is the possibility of a paradigm shift occurring which might result in your strategy becoming ineffective.
Review
Post-trade analysis offers you an ideal way to improve your trading. Considering which elements went well, and which elements did not, can allow you to incorporate ways of optimising returns, or limiting losses, on future trades:
- Look at whether the underlying market conditions changed during the life of your trade, and how this impacted performance.
- Establish which indicators gave off the best signals regarding entry or exit points.
- Evaluate whether you stuck with your planned strategy or not.
- Think about how you could improve your trading psychology.
Tip: Time frames and holding periods should also be reviewed; did you close out a trade too early or too late?
Why follow a trade process strategy?
Following a trade process strategy ensures that you incorporate all of the possible factors that might influence the price of an asset into your planning.
The process of moving from one stage to another can form a natural break, which should mean that the “review” element of your trading strategy forms a continuous part of your approach.
The methods mentioned above are generic enough to allow them to be applied to any market. Once you have developed the core skills, it is possible to use technical analysis to find the markets that best suit your risk-profile and personal investment style.
Final thoughts
Technical analysis tools can be used in any trading plan. They fit into the trading process, regardless of whether you are a buy-and-hold investor basing decisions on fundamental analysis, or a day trader looking to profit from short-term moves.
Developing a trading process can help you to introduce technical analysis themes at the optimal time and make the best decisions possible.
Visit the eToro Academy to learn more about utilising technical analysis.
Quiz
FAQs
- What should I do when technical analysis does not support fundamental analysis?
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Technical analysis indicators are an important tool for double-checking investment decisions drawn from other schools of thought, such as fundamental analysis. Using it can help you to optimise trade entry and exit points by highlighting the fact that the market may, in the short-term at least, move in the other direction. This does not necessarily invalidate your fundamental analysis but suggests that patience could be key.
- What other forms of analysis are there?
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Fundamental analysis and quantitative analysis are two popular alternatives to technical analysis. The former considers real-world events, the underlying characteristics of a market and economic cycles. Quantitative analysis is based on numbers, focusing on statistics and data relating to the factors that can drive price.
- What is back-testing?
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Back-testing involves applying a strategy to a previous period of time. This can allow you to see if a strategy would have been successful or not. Of course, there is no guarantee that positive past performance will translate into future returns, but it can give you an insight into how your strategy might react in certain market conditions.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.