Understanding Basic Assumptions of Technical Analysis

To understand the field of technical analysis,the reasons ,the cause and effect relationship of prices, we have to understand and always remember three easy foundation principles, as these are the three primary assumptions on which Technical Analysis is based upon:

1.     Prices discount everything.

2.     Prices move in a trend.

3.     History tends to repeat itself.

1. The Prices Discount Everything

The very first  assumption  of Technical Analysis says that existing current market price of a share which we are witnessing reflects all possible hopes, fear, information of all the existing market players which could actually affect the price. Few people buy on the hope that scrip will rise to represent the true worth , few buy on the basis of the inside information but all these factors are reflected in the price at which the scrip is priced by the forces of demand and supply on the trading floor. So whatever reason provokes the buyer to buy and the seller to sell gets reflected in the price on the exchange.

Note the news which reached to the traders is always STALE and is of no use for the purpose of trading.

2. The prices moves in a Trend

The second assumption of technical analysis is that the prices always move in a trend, which enables an analyst to ride a fresh trend which has been established till the existing trend reverses. If prices would have been random or erratic , it would be extremely difficult to catch the movement.One existing trend becomes  reason for the occurrence of the other trend which helps in predicting the future price movements.

3. History Tends To Repeat Itself

Another important assumption of technical analysis is that history tends to repeat itself over and again. Like an Economic cycle  or a product life cycle ,prices(trends) for a share also has a cycle.

This assumption evolved out of the fact that that human psychology ,that the recurring nature of price movements is due to the reactions of market participants to similar market stimuli over the time. Like in the bull market participants drive the prices upwards and this practice will be seen in every bull market. Therefore the chart patterns already seen will often repeat themselves.

Let us understand the above assumptions with the help of a perfect example of RECLTD chart

RECLTD prices very much justifies the second  and third assumption ,that the prices moves in a trend and history repeats itself.

RECLTD prices were in uptrend since March 2016 till May 2017 and then trend was taken over by bears and remained bearish till July 2018. 

Now as we know history repeats itself prices are again bullish.