Technical analysis is a trading discipline used to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysis, which tries to assess the value of a security based on business results such as sales and earnings, technical analysis focuses on studying prices and volumes.
Technical analysis
Understanding technical analysis
Technical analysis tools are used to scrutinize the ways supply and demand for security will affect changes in price, volume, and implied volatility. It works on the assumption that past trading activity and the price change of a security can be valuable indicators of a security's future price movements when combined with appropriate investment or trading rules.
It is often used to generate short-term trading signals from various charting instruments. Still, it can also help improve the assessment of a security's strengths or weaknesses relative to the broader market or one of its sectors. This information helps analysts improve their overall valuation estimates.
Charles Dow and Dow Theory first introduced technical analysis as we know it today in the late 1800s by William P. Hamilton, Robert Rhea, Edson Gould, and John Magee further contributed to the Dow Theory concepts that helped form its basis. Today, technical analysis has evolved to include hundreds of patterns and signals developed over years of research.
Professional analysts often use technical analysis in conjunction with other forms of research. Retail traders can make decisions based solely on a stock's price chart and similar statistics, but practicing stock analysts rarely limit their research to the scope of fundamental or technical analysis.
Technical analysis can be applied to any security with historical trading data. This includes stocks, futures, commodities, fixed income, currencies, and other securities. In fact, technical analysis is much more common in commodity and forex markets, where traders focus on short-term price movements.
Technical analysis attempts to forecast the price movements of virtually any tradable instrument generally influenced by supply and demand, including stocks, bonds, futures, and currency pairs. In fact, some people view technical analysis as simply studying the forces of supply and demand reflected in the market price movements of a security.
Technical analysis usually applies to price changes, but some analysts track numbers other than the price, such as trading volume or open interest rate figures.
Technical analysis indicators
Across the industry, there are hundreds of patterns and signals that have been developed by researchers to support technical analysis trading. Technical analysts have also developed a variety of trading systems to help them forecast and trade on price movements.
Some indicators focus primarily on identifying current market trends, including areas of support and resistance, while others focus on identifying the strength of the trend and its likelihood of continuation. Commonly used technical indicators and chart patterns include trend lines, channels, moving averages, and momentum indicators. In general, technical analysts consider the following broad types of indicators:
Price trend
Chart templates
Volumes and momentum
Oscillator
Support and resistance levels
Fundamental Assumptions of Technical Analysis
There are two main methods used to analyze stocks and make investment decisions: fundamental analysis and technical analysis. Fundamental analysis involves analyzing a company's financial statements to determine the fair value of the business, while technical analysis assumes that the price of security already reflects all public information and instead focuses on a statistical analysis of price movements.
Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends instead of analyzing the fundamental attributes of securities.
Charles Dow released a series of editorials discussing the theory of technical analysis. His writings include two fundamental assumptions that have further formed the framework for technical analysis trading. The market works efficiently with values that represent factors that affect the price of a security, but even random market price movements seem to move in identifiable patterns and trends and tend to repeat over time.
Today the field of technical analysis is built on the work of Dow. Professional analysts generally accept three general assumptions for the discipline:
Markets depreciate everything: Technical analysts believe that everything from company fundamentals to broad market factors to market sentiment has been priced into stocks. This view is consistent with the Effective Market Hypothesis (EMH) which assumes a similar conclusion about prices. The only thing left is price movement analysis, which technical analysts see as the product of supply and demand for a particular stock in the market.
Price moves with trends: Technical analysts expect that the price, even in random market movements, will show the trend regardless of the time frame observed. In other words, stock prices are more likely to continue past trends than erratic fluctuations. Most technical trading strategies are based on this assumption.
History tends to repeat itself: Technical analysts believe history tends to repeat itself. The repetitive nature of price movements is often attributed to market sentiment, which tends to be very predictable based on emotions such as fear or excitement. Technical analysis uses chart patterns to analyze these emotions and subsequent market movements to understand trends. While many forms of technical analysis have been used for over 100 years, they are still thought to be relevant as they illustrate patterns in price movements that are often repeated.
How can I learn technical analysis?
There are many ways to learn technical analysis. The first step is to learn the basics of investing, stocks, markets, and finance. All this can be done through books, online courses, online materials, and classes. After understanding the basics, from there you can use the same types of documents but with a special focus on technical analysis.
