Technical analysis is a process used to quantify the price action on the chart of a security and identify trading and investing opportunities based on the patterns created by buyers and sellers. Technical analysts believe past and present trading activity in price changes can be used to create an edge for what will happen next based on what is happening now. Technical analysts try to establish a higher probability of one thing happening over another or to create a good risk/reward ratio through trade entry and management as it plays out.

How many types of technical analysis are there?

There are two major schools of thought within technical analysis: predictive technical analysis and reactive technical analysis.

Predictive technical analysis is practiced when traders project what will happen next in price movement based on a current chart pattern. They look for the clues of volume, trendlines, and the levels of support and resistance to project the probabilities of the future price movement. It’s an attempt to predict the future price action based on the past price pattern.

Reactive technical analysis is practiced when trader’s entries and exits are based on current price signals that backtest as profitable by creating good risk/reward ratios. Their quantified price signals tell them when to get in for a good probability of success and where to get out with a small loss or to lock in a profit. Reactive traders rely on trade management as the price action plays out to minimize losses and maximize gains for profitability. They rely on quantified systems to make money in the markets, not knowing the future.

The best use of both types of technical analysis is to create good risk/reward ratios on entry. You know where you will be getting out if the trade doesn’t work out and the potential magnitude of the win if you are right. This is the true value of technical analysis.

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