Technical Analysis is the forecasting of future financial price movements based on an examination of past price movements. It is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Technicians using charts search for archetypal price chart patterns, such as the well-known head and shoulders or double top/bottom reversal patterns, study technical indicators, moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants, balance days and cup and handle patterns. Technical analysis can help investors anticipate what is “likely” to happen to prices over time. Is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand.
Technical analysts also widely use market indicators of many sorts, some of which are mathematical transformations of price, often including up and down volume, advance/decline data and other inputs. These indicators are used to help assess whether an asset is trending, and if it is, the probability of its direction and of continuation.
Technical analysis is applicable to securities where the price is only influenced by the forces of supply and demand. Technical analysis does not work well when other forces can influence the price of the security.
KEY ASSUMPTION:
- High liquidity
- No artificial price changes (splits, dividends, and distributions)
- No extreme news
WEAKNESSES OF TECHNICAL ANALYSIS
- Personal bias – Technical analysis is subjective, and our personal biases can be reflected in the analysis. It is important to be aware of these biases when analyzing a chart.
- Different interpretation – Even though there are standards, many times two technicians will look at the same chart and paint two different scenarios or see different patterns.
- Too late – By the time the trend is identified, a substantial portion of the move has already taken place.
- Another level – Even after a new trend has been identified, there is always another “important” level close at hand. Technicians have been accused of sitting on the fence and never taking an unqualified stance.
- Trader’s remorse – Not all technical signals and patterns work.
Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more of an art form than a science.
