Introduction to Financial Technical Analysis

Technical analysis—these words may conjure up many different mental images. Perhaps you think of the stereotypical technical analyst, alone in a windowless office, slouched over stacks of hand-drawn charts of stock prices. Maybe you think of the sophisticated multicolored computerized chart of your favorite stock you recently saw. Possibly you think of a proprietary

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The Basic Principle of Financial Technical Analysis – The Trend

After reading this chapter, you should be able to Define the term trend Explain why determining the trend is important to the technical analyst Distinguish between primary, secondary, short-term, and intraday trends Discuss some of the basic beliefs upon which technical analysis is built The art of technical analysis—-for it is an art—is to

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How Does the Financial Technical Analyst Make Money? What Is a Trend?

1. How Does the Financial Technical Analyst Make Money? Several requirements are needed to convert pure technical analysis into money. The first and most important, of course, is to determine when a trend is beginning or ending. The money is made by “jumping” on the trend as early as possible. Theoretically, this sounds simple,

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How Are Trends Identified?

There are a number of ways to identify trends. One way to determine a trend in a data set is to run a linear least-squares regression. This statistical process will provide information about the trend in security prices. Unfortunately, this particular statistical technique is not of much use to the technical analyst for trend

Trends Develop from Supply and Demand What Trends Are There?

As in all markets, whether used cars, grapefruit, real estate, or industrial products, the economic principle of interaction between supply and demand determines prices in trading markets. Each buyer (demand) b ids for a certain quantity at a certain price, and each seller (supply) offers or asks for a certain quantity at a certain

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What Other Assumptions Do Financial Technical Analysts Make?

That markets trend is the basic principle underlying the theory of technical analysis. Of course, the price of the securities that are being monitored form the trend. Supporting this notion of trending prices, technical analysts have made several other assumptions that we cover briefly. First, technical analysts assume that price is determined by the

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Early Financial Markets and Exchanges

Although technical analysis is thought to be an ancient method of analyzing markets and prices, its history has been poorly recorded. We do not have recorded evidence of technical analysis being used in ancient times, but it is conceivable that technical analysis, in some form, was used in the distant past in freely traded

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Modern Financial Technical Analysis

Although the practice of technical analysis in some forms likely dates back many centuries, Charles Dow (1851-1902) was the first to reintroduce and comment on it in recent times. He is considered the father of “modern” technical analysis. Dow’s introduction of stock indexes to measure the performance of the stock market and by inference

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Current Advances in Financial Technical Analysis

Interest in technical analysis is resurging. The Efficient Markets Hypothesis (EMH) has been found to have a number of serious flaws, and stock price motion is being shown to be nonrandom. This new knowledge has cast doubt on the objections raised earlier about technical analysis, and academics are gradually beginning to perform serious studies

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Do Markets Follow a Random Walk?

Opponents of technical analysis claim that looking at past technical data, such as price and volume, to help predict the future is outlandish. In the popular book A Random Walk Down Wall Street, Burton Malkiel refers to technical analysis as “sharing a pedestal with alchemy.” Some of these opponents believe that no underlying patterns

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Can Past Patterns Be Used to Predict the Future?

Some researchers who have accepted that stock prices do not follow a random walk still do not accept the validity of technical analysis. These opponents agree that there may be patterns that can be fitted to stock price movement after the fact, but they argue that these past patterns cannot be used to predict

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What About Market Efficiency?

Because of the central role the EMH has played in financial theory in the past 50 years, we spend a little time developing the basic ideas of the EMH and how, although it might be an interesting and thought- provoking model, it does not describe the real world of investments and markets. Market efficiency

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Behavioral Finance and Technical Analysis

Behavioral finance is a quickly growing subfield of the finance discipline. This branch of inquiry focuses on social and emotional factors to understand investor decision making. Behavioral finance studies have pointed to cognitive biases, such as mental accounting, framing, and overconfidence, which impact investors’ decisions. These studies suggest that investors often act irrationally, sometimes

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Pragmatic Criticisms of Financial Technical Analysis

In addition to the theoretical criticisms of technical analysis, there are some pragmatic criticisms of technical analysis. Some investors incorrectly believe that technical analysis is only for the short-term trader and is not useful to the long-term investor. Because new and relevant fundamental information on a security doesn’t change minute by minute or day

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What Is the Empirical Support for Technical Analysis?

Despite the theoretical criticisms, can technical analysts use past price data to predict future price movement? Over the years, hundreds of studies have been conducted to test the efficacy of technical trading rules. Cheol-Ho Park and Scott Irwin conducted one of the most extensive reviews of these tests. In their 2003 report, they review

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In What Types of Markets Can Technical Analysis Be Used?

Markets are simply meeting places of buyers and sellers. Markets can be categorized in many ways. They can be categorized by the assets being traded, the manner in which the borrowers and lenders meet, or the type of contract that is executed. Let us begin by dividing markets into categories based on how organized

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Types of Contracts in Markets

Now let us look at categorizing markets by the type of contract that is executed. Two broad contract categories are the cash market and the derivative market. The futures market and the option market are subcategories of the derivative market. Table 5.1 shows the types of assets that might be bought and sold in

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How Does a Market Work?

To understand the principles of technical analysis, we must be familiar with how markets work and who the players might be. To better understand how market prices are set, let us begin with a hypothetical trading example. Let us assume that we are watching the trading post on the New York Stock Exchange where

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Who Are the Market Players?

From the preceding example, it is obvious that a number of different individuals participate in establishing the price of a security. Academia has divided these types of participants into three separate categories: informed, noise, and liquidity players. The early Efficient Markets Hypothesis presumed that only informed investors acted within the marketplace to establish a

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How Is the Market Measured?

As more of the market players want to buy stocks and fewer want to sell their stock holdings, stock prices will be driven up. Likewise, if many market players want to sell their stocks relative to the number of participants who want to buy stocks, stock prices will fall. Looking at the increase or

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