Technical analysis

June 26th, 2008

Did you ever heard of Fibonacci, moving averages or candlestick charting? Well, these are few of technical analysis basic tools. Technical investors believe that all the information about a given stock can be viewed by reviewing its past and present statistics, such as the trend in the volume of stocks traded and the stock price chart (the graph of the stock price change over time). Then, by mathematically analyzing the behavior of the graph and using statistical analysis they (hypothetically) can identify patterns suggesting the future behavior of the price.

Usually, technical analysis is used for the short term, since it is too hard to predict patterns way into the future (although there are some who try).

There are three basic assumptions behind technical analysis. The first states that stock price reflects everything you need to know; therefore, technical analysts assume that fundamental factors and the market psychology are already priced into the price. Second, technical analysis assumes that price of a stock moves in trends. This means that after a trend has been established, the future trend is more likely to continue in the same direction than going against it.

Finally, technical analysis is strongly based on the underlying assumption that historical patterns tend to repeat themselves. In simple words, it means that investors tend to react more or less the same way to similar market events over time.

Although it may seem straightforward, there is almost infinite number of mathematical techniques and tools for technical analysis. Most of the technicians are first trying to figure out the overall trend of the price change in order to conclude if it is an uptrend or downtrend. Mathematical pattern descriptions such as moving averages, oscillators and other indicators are the tools which assist the technical investor to apply this analysis.

Then, the investors start to understand the smaller details inside the trend and see if there is any support or resistance to this trend. For example an uptrend with a support in trading volume could be a good indicator for the stock price to continue climbing up. This might be a good time to buy the stock. On the other hand, if there is a strong resistance to the uptrend, it might be a good time to sell if you hold the stock.

Technical analysis is not simple and definitely not absolute. In addition technical investors want to know even more details. They also want to know for example the specific shape of the graph pattern; it could be classified as having a head shape, a shoulder, a cup or even a handle.

Feel confused? It is OK. Technical analysis is complicated at first sight. The large variety of techniques requires you to educate yourself regarding its basic rules. Then, if you choose to use it, you will have to improve your skills by practicing the different techniques. Yalicoo is a great place for this purpose (and we will get to that shortly).

There is a vast debate both in the academic and in the private world about the capability of these technical techniques to beat the market. Studies tend to show that technical analysis does not work for the long run, but it is much harder to test it on the short run, since many of technical analysis conclusions are not that conclusive.

Last 5 posts by Yinon Arieli

• How cheap are stocks now? - October 26th, 2008
• New Wall Street Terminology - October 18th, 2008
• What does Warren say? - October 15th, 2008
• Should you buy now or wait for a better time? - October 2nd, 2008
• Understanding Fundamental and Technical Analysis - September 27th, 2008

Entry Filed under: Stock Trading Investing strategies