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Technical Analysis

Definition

In finance, technical analysis is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Behavioral economics and quantitative analysis use many of the same tools of technical analysis, which, being an aspect of active management, stands in contradiction to much of modern portfolio theory. The efficacy of both technical and fundamental analysis is disputed by the efficient-market hypothesis which states that stock market prices are essentially unpredictable.

Technical analysis is a way to analyze stocks. The term refers to the study of market that is based on the action and movement of the market price. The understanding of the study is derived through price charts that indicate relevant forecasting based on the trading history, statistics, and market trends. Therefore, technical analysis takes into account the recent and past prices, actual price behavior, and other relevant factors that help the investor.

Financial analyst and professionals make use of technical analysis majorly in the foreign exchange market to analyze securities. In other terms, technical analysis studies the demand and supply of the market which helps in evaluating the market trends.

How does this work?

In order to carry out technical analysis, the investors start by understanding the charts and figures related to the history of the trading volume for an index or security. Besides these, various statistical measures (percentage changes, minimums, maximums and averages) are also taken into consideration.

Assumptions of technical analysis:

  • The market is cyclic. History will repeat itself
  • The market trends determine the prices
  • The market is discounted

Characteristics of technical analysis:

  • First, it employs the rule for trading based on the business cycle, volume and price, regressions, averages and other indicators.
  • Second, when technical analysis determines the price, volume and other similarities, it also takes into account other facts including company, currency, commodity, and the market.
  • Mostly used by traders, in particular the active day traders, market makers, and pit traders

Key indicators of technical analysis:

These indicators are commonly used in the process of technical analysis which also works as ‘buy or sell’ signals in the stock/trading market.

  • Moving Average Convergence Divergence (MACD)
  • On-Balance Volume
  • Average Directional Index
  • Aroon Indicator
  • Relative strength Index

Why is technical analysis important?

These are unlike the fundamental analysis that is based on finding true value of a security through the study of macroeconomic event, competition, financial statements, etc.

Technical analysis is more focused on predicting the future market and individual stocks by analyzing the past market trends. When the investor successfully interprets graph readings and accordingly predict the movement of the stock, chances are that he or she will make a lot of good money.


Further Reading


The use of technical analysis in the foreign exchange market
www.sciencedirect.com [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

On technical analysisOn technical analysis
academic.oup.com [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

Neural network techniques for financial performance prediction: integrating fundamental and technical analysisNeural network techniques for financial performance prediction: integrating fundamental and technical analysis
www.sciencedirect.com [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

Stock-market" patterns" and financial analysis: methodological suggestionsStock-market" patterns" and financial analysis: methodological suggestions
www.jstor.org [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

Market efficiency and the returns to technical analysisMarket efficiency and the returns to technical analysis
www.jstor.org [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

The obstinate passion of foreign exchange professionals: technical analysisThe obstinate passion of foreign exchange professionals: technical analysis
www.aeaweb.org [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

Is technical analysis in the foreign exchange market profitable? A genetic programming approachIs technical analysis in the foreign exchange market profitable? A genetic programming approach
www.jstor.org [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …

How rewarding is technical analysis? Evidence from Singapore stock marketHow rewarding is technical analysis? Evidence from Singapore stock market
www.tandfonline.com [PDF]
… MURPHY, JJ, Technical Analysis of the Futures Markets, New York: New York Institute of … Reversion in Stock Prices: Evidence and Implications,' Journal of Financial Economics, October 1988 … RJ, 'Stock Prices and Social Dynamics,' Bookings Papers on Economic Activity, 1984, 2 …



Q&A About Technical Analysis


What is technical analysis?

Technical analysis refers to the study of market that is based on the action and movement of the market price.

What are some examples of statistical measures used in technical analysis?

Percentage changes, minimums, maximums and averages are all statistical measures used in technical analysis.

Why do investors use technical indicators when making a decision about buying or selling a stock?

Investors use these indicators as buy or sell signals in the stock trading market. These signals differ from fundamental indicators which focus on finding true value through macroeconomic event, competition and financial statements.

How does technical analysis work?

Technical analysis works by analyzing past prices, actual price behavior, and other relevant factors.

What are some examples of technical indicators used in technical analysis?

Examples include percentage changes, minimums, maximums, averages.