Technical Analysis

Introduction

Technical Analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security's intrinsic value, technical analysts focus on charts of price movement and various analytical tools to evaluate a security's strength or weakness.

History

The principles of technical analysis are derived from hundreds of years of financial market data. Some aspects of technical analysis began to appear in Amsterdam-based merchant Joseph de la Vega's accounts of the Dutch financial markets in the 17th century. However, modern technical analysis as a whole is primarily derived from the work of Charles Dow, co-founder of Dow Jones & Company, and the creator of the Dow Theory.

Basic Concepts

Technical analysis can be as complex or as simple as you want it to be. While technical analysis can be quite intensive, there are a few basic concepts that form the foundation of this type of analysis.

Price Action

Price action is a method of bill trading strategy that examines the movements of the price itself. It encompasses the most fundamental concept of understanding the market structure through the movement of the price over time, from which all other strategies are based.

Trend

The trend is the general direction of a market or of the price of an asset. Trends can vary in length from short, to intermediate, to long term. If you can identify a trend, it can be highly profitable, because you will be able to trade with the trend.

Support and Resistance

Support and resistance represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying.

Volume

Volume is one of the most basic and beneficial concepts to understand when trading stocks. Volume is defined as, "the number of shares (or contracts) traded during a given period of time."

Types of Charts

There are several types of charts used in technical analysis. These include the line, bar, and candlestick charts.

Line Charts

A line chart is a type of chart which displays information as a series of data points called 'markers' connected by straight line segments. It is a basic type of chart common in many fields.

Bar Charts

A bar chart is a chart with rectangular bars with lengths proportional to the values that they represent. The bars can be plotted vertically or horizontally. A vertical bar chart is sometimes called a line graph.

Candlestick Charts

A candlestick chart is a style of financial chart used to describe price movements of a security, derivative, or currency. Each "candlestick" typically shows one day, thus a one-month chart may show the 20 trading days as 20 candlesticks.

Technical Indicators

Technical indicators are a fundamental part of technical analysis and are typically plotted on the top of the price movements on a chart. These indicators can be used to identify trends, as well as create buy and sell signals.

Moving Averages

A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random short-term price fluctuations.

Relative Strength Index

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. The RSI oscillates between zero and 100. Traditionally the RSI is considered overbought when above 70 and oversold when below 30.

Moving Average Convergence Divergence

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price.

Criticism and Controversy

While many practitioners of technical analysis believe that all current information is reflected in prices, critics contend that past trading activity can also reflect irrational exuberance or excessive pessimism. As a result, technicians often disagree among themselves about the validity and reliability of their techniques.