What is Technical Analysis?
Technical analysis is a method of security analysis discipline of forecasting the direction of prices through the study of past market data, primarily the price and volume.
Technical analysis employs methods and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, business cycles, stock market cycles and through recognition of chart patterns like candlestick charts. It is commonly used as a method to find trends in stock prices.
Benefits of Technical Analysis
Technical analysts believe that prices trend directionally up, down, or sideways or some combination. The basic definition of a price trend was originally put forward by Dow Theory.
An example of a security that had an apparent trend is AOL from November 2001 through August 2002. A technical analyst or trend follower recognizing this trend would look for opportunities to sell this security. AOL consistently moves downward in price. Each time the stock rose, sellers would enter the market and sell the stock; hence the "zig-zag" movement in the price. The series of "lower highs" and "lower lows" is a tell tale sign of a stock in a down trend.] In other words, each time the stock moved lower, it fell below its previous relative low price. Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that does not pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.
Technical vs Fundamental Analysis:
Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the actual facts of the company, market, currency or commodity. Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team. In the 1960s and 1970s it was widely dismissed by academics.
Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. In the foreign exchange markets, its use may be more widespread than fundamental analysis. This does not mean technical analysis is more applicable to foreign markets, but that technical analysis is more recognized as to its efficacy there than elsewhere.
Evaluating Technical Analysis
According to Jeremy Siegel, author of Stocks for the Long Run,: “recent studies have been done on technical analysis, and the results have been surprisingly positive.” Furthermore, according to Professor Peter Navarro, author of The Modern Scholar, “Technical and fundamental analysis should be used for stock picking. You need to use both fundamental and technical analysis...it prevents investing traps like investing on emotions...Track the Technical characteristics of your stock to prevent these traps.”