Technical analysis has a long history and can be traced back to rice trading during the Tokugawa Shogunate era in Japan (1603-1867). During that time, to predict the price trends of rice, a merchant named Homma Munehisa invented the prototype of candlestick charts to record changes in rice prices. Over several centuries of development and inheritance, technical analysis has branched out into various comprehensive theories, including basic K-line charts, technical indicators, Dow Theory, Elliott Wave Theory, Gann Theory, and Wrapped Theory, among others.
Different technical analysis theories employ various methods, but the core principle of each method is to use K-line charts or historical price movements to predict future market price movements, aiming to profit from the forecasted trends.
It is essential to note that besides the common technical analysis theories mentioned earlier, there is a wide variety of other technical analysis theories available in the market. These theories vary in complexity and may be more suitable for different types of investors. Investors can make informed choices by considering factors such as their own characteristics and personality. This article briefly introduces several comprehensive technical analysis theories. However, it is crucial to understand that technical analysis is not a foolproof approach and often requires a combination of fundamental analysis to identify promising investment opportunities.
Technical analysis is based on three major assumptions: ①Market Behavior Incorporates All Information ②Prices Move in Trends ③History Repeats Itself.
① Market Behavior Incorporates All Information
There is no need to give excessive attention to the specific content of factors influencing prices. According to the Efficient Market Hypothesis (EMH), in a competitive and fully transparent market, the market price trend reflects a comprehensive integration of all market information, including project fundamentals, macroeconomics, token supply, and other factors. This assumption forms the foundation of technical analysis, and without its recognition, technical analysis would be rendered meaningless.
② Prices Move in Trends
Price movements reflect changes in supply and demand dynamics over a certain period. Once the supply and demand relationship is established, price changes are expected to continue in a determined direction, which is often the path of least resistance. Trend analysis and interpretation are at the core of technical analysis, making the second assumption the fundamental premise of technical analysis.
③ History Repeats Itself
When the market exhibits the same or similar patterns as seen in the past, investors may use their past successful experiences or lessons from failures to make current investment decisions. This belief is based on the idea that market behavior and price trends tend to repeat historical patterns.
The four major factors in technical analysis are price, volume, time, and space. Technical analysis methods may vary, but they all revolve around these four aspects.
Price and volume are the most fundamental expressions of market behavior. Price refers to the actual trading price reached through sufficient negotiations between buyers and sellers. Volume represents the form of supply and demand and indicates the amount traded within a unit of time. The price and volume at a specific time can reflect the common market behavior of both buyers and sellers at that time, indicating a temporary equilibrium point. When there is little agreement and significant divergence between buyers and sellers, the trading volume tends to be high. Conversely, when there is substantial agreement and minimal divergence, the trading volume tends to be low.
In technical analysis, time refers to the duration required to complete a certain process. It often refers to the time taken for a technical pattern (e.g., a triangle) or a price movement within a certain range to occur. On the other hand, "space" refers to the extent to which prices can rise or fall. Generally, for longer time periods, the potential price movement space is expected to be larger, while for shorter time periods, the potential price movement space is expected to be smaller.
The Dow Theory is considered the predecessor of all market technical analysis theories. It was developed by Charles Henry Dow, who founded Dow Jones & Company and created the Dow Jones Industrial Average, as well as the famous newspaper, "The Wall Street Journal." During the period from 1900 to 1902, Charles Dow published numerous articles about the stock market in the newspaper, expressing his views on the stock market trends. After his death, the journalists of "The Wall Street Journal" compiled his articles and views into a book titled "Dow Theory Unplugged," officially naming the theory. The Dow Theory is a comprehensive trend-following theory with a complex system, encompassing three major assumptions and five main principles.
From the three major assumptions and five main principles, we can distill the core of the Dow Theory, which represents the three types of trends in price changes depicted in the K-line charts: ① Primary Trend ② Secondary Trend ③ Minor Trend.
Diagram Illustrating the Three Trends in Dow Theory
①Primary Trend
The primary trend typically lasts for one year or more and can be broadly classified into a bull market, a bear market, or a consolidation range.
②Secondary Trend
The secondary trend moves in the opposite direction to the primary trend and usually lasts for around three weeks to several months. During this period, the retracement range typically spans from one-third to two-thirds of the distance between the low and high points of the primary trend.
③Minor Trend
The minor trend represents daily K-line chart price adjustments within the secondary trend. It is often challenging to analyze minor trends individually. However, analyzing the primary and secondary trends relies on assessing the minor trend.
The Elliott Wave Theory was introduced in the 1930s by American securities analyst Ralph Nelson Elliott. Through several decades of studying hourly charts of the Dow Jones Industrial Average, Elliott discovered a correlation between stock market price movements and wave patterns. While the Dow Theory provided insights into the concept of trends, the Elliott Wave Theory delves into a more detailed characterization of these trends.
① Wave Structure
Based on the Dow Theory's classification of market trends, the Elliott Wave Theory divides market cycles into eight waves, comprising five impulse waves and three corrective waves. Each wave contains smaller waves (subwaves), and each wave is also contained within a larger wave. In a bullish eight-wave model, the five impulse waves are upward-trending and typically labeled as waves 1, 2, 3, 4, and 5, while the corrective waves are downward-trending and generally marked as waves A, B, and C. Conversely, in a bearish market, the five impulse waves are downward-trending, and the corrective waves are upward-trending.
A Bull Market Wave Model
② Nested Wave Structure
Wave structures are not merely simple cycles but can be nested within each other. This means that any price wave can simultaneously exist within different levels of price cycles (corresponding to the concepts of primary trends, secondary trends, and daily fluctuations in the Dow Theory).
In other words, a complete 5-wave or 3-wave structure can constitute a smaller wave within a larger wave cycle. Conversely, any small wave within a wave cycle can be further broken down into the micro-structures of impulse waves or corrective waves.
The Dow Theory, Elliott Wave Theory, and Gann Theory are collectively known as the three major technical analysis theories in the Western financial world. Among them, Gann Theory is undoubtedly the most complex and challenging to apply.
William Gann was one of the most successful investors of the 20th century, amassing over 300 million dollars in profits during his investment career of more than 50 years. Gann believed that market price trends were not random but could be predicted through mathematical methods, and he developed a theory that perfectly combined time and price.
Through the comprehensive application of mathematics, geometry, religion, and astronomy, Gann created his unique technical analysis theory. The Gann Theory includes the following components: ①Gann's 21 Trading Rules ②Gann's 12 Trading Rules ③Gann's Retracement Rule ④Gann's Cycle Theory ⑤Gann's Swing Rule ⑥Gann's Division of Price Ratios ⑦Gann's Market Geometric Principles ⑧Gann's Market Forecasting Tools.
The following are some core concepts of Gann Theory:
① Price Fluctuations are A Fundamental Rule Governing Market Cycles
Price fluctuations occur in the form of uptrends and downtrends. When prices transition from an uptrend to a downtrend, important support levels are often observed at 25%, 50%, 75%, etc. Conversely, when prices start rising from a low point, significant resistance levels can be observed at 1.25, 1.5, 2, etc.
② Duration of Market Rebounds
In uptrends, if measured in months, adjustments typically do not last more than 2 months. If measured in weeks, adjustments generally occur within a range of 2 to 3 weeks. On the other hand, during significant market declines, short-term rebounds can last around 3 to 4 months.
③ Time as a Reference Point for Cycle Analysis
Long-term cycles have timeframes of 20 years, 30 years, 60 years, and even longer. Medium-term cycles have timeframes of 1 year, 2 years, 3 years, and so on, up to 15 years. The significance of the 30-year cycle is emphasized because it consists of 360 months, which is a complete circle in degrees. Short-term cycles have timeframes of 24 hours, 12 hours, and even as short as 4 minutes. This is because there are 1,440 minutes in a day, and dividing this by 360 results in 4 minutes, which represents a degree of rotation on Earth.
④ The Significant 10-Year Cycle
Turning points in the market that occurred 10 years ago can be used to predict similar turning points that may happen 10 years later. In addition, the 7-year cycle is also an important turning point, as 7 days, 7 weeks, and 7 months are all significant intervals.
If the Dow Theory, Elliott Wave Theory, and Gann Theory are considered products of Western thought, the Wrapped Theory is undoubtedly a manifestation of Eastern thinking. The Wrapped Theory is a technical analysis theory system invented by a Chinese internet figure known as "缠中说禅," and it originated from a series of articles titled "How to Trade Stocks" written by "缠中说禅" on June 7, 2006.
The core of the Wrapped Theory is to gradually deduce the structure of market trends through geometric analysis, thereby scientifically and comprehensively classifying various market trends to guide practical trading operations. Through this scientific approach, the Wrapped Theory has formulated the core principle of "Trends Must Be Perfect."
Specifically, "Trends Must Be Perfect" includes the following aspects. Firstly, trends can be categorized into three types: uptrends, downtrends, and consolidations. Secondly, all types of trends must complete their respective cycles. Thirdly, any completed trend type must contain a central pivot, which consists of three smaller sub-trends. Fourthly, after the completion of any trend type, it will inevitably transform into one of the other two trend types. For example, the end of a downtrend will lead to either a consolidation or an uptrend.
The Wrapped Theory and Gann Theory are both complex technical analysis theories. For a more detailed understanding, one can search for "The 108 Lessons of the Wrapped Theory," but this article will not delve into it extensively.
Due to the desire for wealth, technical analysis is highly sought after by many individuals. However, the ever-changing trends of the market, coupled with greed and fear, make it challenging to predict, leading to potential "distortions" in technical analysis. Fundamental analysis, on the other hand, discards many subjective factors and can partially address the drawbacks of technical analysis. Only by combining both methods can investors potentially identify suitable investment opportunities. In the next article, we will provide a brief introduction to fundamental analysis of trading.
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