What is Technical Analysis?

Most beginning traders or active investors don’t really have a firm understanding of what Technical Analysis is before they begin using it.

So let's start by answering this very basic question…

What is Technical Analysis?

Technical Analysis is described as a method of analyzing a security based on statistics such as prior price data, volume, and chart patterns.

Technical Analysis uses charts, price patterns, volume analysis, indicators and oscillators in an attempt to predict and profit from future price movement.

Technical Analysis differs from Fundamental Analysis by concentrating only on the “charts” and it ignores things like earning numbers, future revenue, price to book ratios, or anything having to do with the intrinsic value of the security.

The theory of Technical Analysis is really based on 3 assumptions.

The first assumption is that everything that is known about a security is directly represented by its price and volume action on the chart.

Technical Analysts believe that doing any kind of Fundamental Analysis is “redundant”.

This is due to the fact that they believe all the relevant information about a security is already known by the “smart money” and the price and volume action on the chart will depict their bias.

Day traders are an extreme example of this practice. Day traders typically use only Technical Analysis to make trading decisions and don’t concern themselves with anything other than the “price action” they see on the chart.

The second assumption is that history repeats itself and therefore historical chart patterns can be used to determine potential future price movement.

Technical Analysts believe that traders repeat the behavior of the traders before them.

For example if a lot of traders were willing to buy when ABC stock was trading at $50 then, based on this belief, if ABC trades at $50 again there will be buyers there again and traders that missed the trade the first time will now make sure they get into the stock this time.

The goal of using Technical Analysis is to forecast future price movement and locate trading opportunities based on these repeatable patterns or methods.

 And the final assumption is that markets trend.

Therefore once a trend is established it is likely that future price movement will continue in the same direction as the trend.

Technical Analysis is really built around this final assumption.

Technical Analysts and traders alike are always trying to locate the trend and most trading methods are categorized as “trend following” strategies.

The “trend is your friend” is a common saying and is based on the belief that finding the dominant direction of the market (the trend) and trading in the direction of it will improve trading results.

Click HERE To learn more about using Technical Analysis in your Swing Trading!