What is Technical Analysis?

Technical analysis is the study of price changes on charts, affected by buyers and sellers positioning themselves to anticipate the next possible market trend. Traders will transact a buy or sell order in response to an economic announcement, a general belief of forthcoming price change, an existing market trend, or for reasons completely unrelated to market analysis. Whatever the reason, traders' collective activities will influence market prices, which are most easily tracked with price charts.

The astute technical analyst can identify these price patterns in the very early stages of formation and put himself or herself in a position to take advantage of the impending trend. Essentially, a technical analyst's goal is to think a step ahead of the trend-following masses.

Technical analysts are guided by the following beliefs:

  • All known, public information about a particular trading vehicle -- including but not limited to fundamental data, (e.g., interest rates, inflation, unemployment, etc.), position holders, external factors that can influence price, etc. -- is already factored into the price.
  • History repeats itself, especially in the financial markets, creating identifiable price patterns.
  • Emotional crowds tend to move in similar directions, creating identifiable, tradable, price trends.

What makes our trading decisions most predictable, ironically enough, is our tendency to make important decisions based on emotion rather than logic. Emotionally driven decisions often do not make for good trades, and tend to be made in accordance with those around us making similar moves. A group of emotional humans making similar decisions at approximately the same time creates distinct price patterns. If traders simply buy and sell only when new data hits the market, then there would be no price change in between the times of data release. Obviously, as the markets are constantly in flux, it's clear this is not the case; much of that fluctuation can be attributed to human emotions.