History

The principles of technica analysis derive from the observation of financial markets over
hundreds of years. [2] The oldest known hints of technical analysis appear inJoseph de la Vega's
accounts of the Dutch markets in the 17th century. In Asia, the oldest example of technical
analysis is thought to be a method developed by Homma Munehisa during early 18th century
which evolved into the use of candlestick techniques, and is today a main charting tool.[3][4]

Dow Theory is based on the collected writings of Dow Jones co-founder and editor Charles
Dow, and inspired the use and development of modern technical analysis from the end of the
19th century. Other pioneers of analysis techniques include Ralph Nelson Elliott and William
Delbert Gann who developed their respective techniques in the early 20th century.

Many more technical tools and theories have been developed and enhanced in recent decades,
with an increasing emphasis on computer-assisted techniques.

This section does not cite any references or [Link] help improve this article by

adding citations to reliable sources. Unsourced material may be challenged and removed. (October 2009)

[edit]General description
Technical analysts seek to identify price patterns and trends in financial markets and attempt to
exploit those patterns.[5] While technicians use various methods and tools, the study of price
charts is primary.

Technicians especially search for archetypal patterns, such as the well-known head and
shoulders or double top reversal patterns, study indicators such as moving averages, and look
for forms such as lines of support, resistance, channels, and more obscure formations such as
flags, pennants or balance days.

Technical analysts also extensively use indicators, which are typically mathematical
transformations of price or volume. These indicators are used to help determine whether an
asset is trending, and if it is, its price direction. Technicians also look for relationships between
price, volume and, in the case of futures, open interest. Examples include the relative strength
index, and MACD. Other avenues of study include correlations between changes
in options (implied volatility) and put/call ratios with price. Other technicians include sentiment
indicators, such as Put/Call ratios and Implied Volatility in their analysis.

Technicians seek to forecast price movements such that large gains from successful trades
exceed more numerous but smaller losing trades, producing positive returns in the long run
through proper riskcontrol and money management.
There are several schools of technical analysis. Adherents of different schools (for
example, candlestick charting, Dow Theory, and Elliott wave theory) may ignore the other
approaches, yet many traders combine elements from more than one school. Some technical
analysts use subjective judgment to decide which pattern a particular instrument reflects at a
given time, and what the interpretation of that pattern should be. Some technical analysts also
employ a strictly mechanical or systematic approach to pattern identification and interpretation.

Technical analysis is frequently contrasted with fundamental analysis, the study

of economic factors that influence prices in financial markets. Technical analysis holds that
prices already reflect all such influences before investors are aware of them, hence the study of
price action alone. Some traders use technical or fundamental analysis exclusively, while others
use both types to make trading decisions.

Users of technical analysis are most often called technicians or market technicians. Some prefer
the term technical market analyst or simply market analyst. An older term, chartist, is sometimes
used, but as the discipline has expanded and modernized the use of the term chartist has
become less popular.[citation needed]

[edit]Characteristics

Technical analysis employs models 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, cycles or, classically, through recognition of chart patterns.

Technical analysis stands in contrast to the fundamental analysis approach to security and

stock analysis. Technical analysis "ignores" the actual nature of the company, market, currency
or commodity and is based solely on "the charts," that is to say price and volume information,
whereas fundamental analysis does look at the actual facts of the company, market, currency or
commodity. For example, any large brokerage, trading group, or financial institution will typically
have both a technical analysis and fundamental analysis team.

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 1960s and 1970s it was
widely dismissed by academics. In a recent review, Irwin and Park[6] reported that 56 of 95
modern studies found it produces positive results, but noted that many of the positive results
were rendered dubious by issues such as data snooping so that the evidence in support of
technical analysis was inconclusive; it is still considered by many academics to
be pseudoscience.[7] Academics such as Eugene Fama say the evidence for technical analysis
is sparse and is inconsistent with the weak form of the efficient market hypothesis.[8][9] Users
hold that even if technical analysis cannot predict the future, it helps to identify trading
opportunities.[10]

In the foreign exchange markets, its use may be more widespread than fundamental analysis.[11]
[12]
 While some isolated studies have indicated that technical trading rules might lead to
consistent returns in the period prior to 1987,[13][14][15][16] most academic work has focused on the
nature of the anomalous position of the foreign exchange market.[17] It is speculated that this
anomaly is due to central bank intervention.[18] Recent research suggests that combining various
trading signals into a Combined Signal Approach may be able to increase profitability and
reduce dependence on any single rule.[19].

[edit]Principles

Stock chart showing levels of support (4,5,6, 7, and 8) and resistance (1, 2, and 3); levels of resistance tend to
become levels of support and vice versa.

Technicians say that a market's price reflects all relevant information, so their analysis looks at
the history of a security's trading pattern rather than external drivers such as economic,
fundamental and news events. Price action also tends to repeat itself because investors
collectively tend toward patterned behavior – hence technicians' focus on identifiable trends and
conditions.

[edit]Market action discounts everything

Based on the premise that all relevant information is already reflected by prices, pure technical
analysts believe it is redundant to do fundamental analysis – they say news and news events do
not significantly influence price, and cite supporting research such as the study by
Cutler, Poterba, and Summers titled "What Moves Stock Prices?"

On most of the sizable return days [large market moves]...the information that the press cites as the
cause of the market move is not particularly important. Press reports on adjacent days also fail to reveal
any convincing accounts of why future profits or discount rates might have changed. Our inability to
identify the fundamental shocks that accounted for these significant market moves is difficult to reconcile
with the view that such shocks account for most of the variation in stock returns. [20]
[edit]Prices move in trends
See also: Market trends

Technical analysts believe that prices trend directionally, i.e., up, down, or sideways (flat) or
some combination. The basic definition of a price trend was originally put forward by Dow
Theory.[5]

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.[21] In other words, each time the stock moved lower, it fell below its previous relative low
price. Each time the stock moved higher, it could not reach the level of its previous relative high
price.

Note that the sequence of lower lows and lower highs did not begin until August. Then AOL
makes a low price that doesn't 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.

[edit]History tends to repeat itself

Technical analysts believe that investors collectively repeat the behavior of the investors that
preceded them. "Everyone wants in on the next Microsoft," "If this stock ever gets to $50 again,
I will buy it," "This company's technology will revolutionize its industry, therefore this stock will
skyrocket" – these are all examples of investor sentiment repeating itself. To a technician, the
emotions in the market may be irrational, but they exist. Because investor behavior repeats itself
so often, technicians believe that recognizable (and predictable) price patterns will develop on a
chart.[5]

Technical analysis is not limited to charting, but it always considers price trends. For example,
many technicians monitor surveys of investor sentiment. These surveys gauge the attitude of
market participants, specifically whether they are bearish or bullish. Technicians use these
surveys to help determine whether a trend will continue or if a reversal could develop; they are
most likely to anticipate a change when the surveys report extreme investor sentiment. Surveys
that show overwhelming bullishness, for example, are evidence that an uptrend may reverse –
the premise being that if most investors are bullish they have already bought the market
(anticipating higher prices). And because most investors are bullish and invested, one assumes
that few buyers remain. This leaves more potential sellers than buyers, despite the bullish
sentiment. This suggests that prices will trend down, and is an example of contrarian trading.

[edit]Industry

The industry is globally represented by the International Federation of Technical

Analysts (IFTA), which is a Federation of regional and national organizations and the Market
Technicians Association(MTA). In the United States, the industry is represented by both
the Market Technicians Association (MTA) and the American Association of Professional
Technical Analysts (AAPTA). The United States is also represented by the Technical Security
Analysts Association of San Francisco (TSAASF). In the United Kingdom, the industry is
represented by the Society of Technical Analysts (STA). In Canada the industry is represented
by the Canadian Society of Technical Analysts. Additional major professional technical analysis
organizations are noted in the External Links section below.

Professional technical analysis societies have worked on creating a body of knowledge that
describes the field of Technical Analysis. A body of knowledge is central to the field as a way of
defining how and why technical analysis may work. It can then be used by academia, as well as
regulatory bodies, in developing proper research and standards for the field. The Market
Technicians Association (MTA) has published a body of knowledge.

[edit]Use

Traders generally share the view that trading in the direction of the trend is the most effective
means to be profitable in financial or commodities markets. John W. Henry, Larry Hite, Ed
Seykota, Richard Dennis, William Eckhardt, Victor Sperandeo, Michael Marcus and Paul Tudor
Jones (some of the so-called Market Wizards in the popular book of the same name by Jack D.
Schwager) have each amassed massive fortunes via the use of technical analysis and its
concepts. George Lane, a technical analyst, coined one of the most popular phrases on Wall
Street, "The trend is your friend!"

Many non-arbitrage algorithmic trading systems rely on the idea of trend-following, as do

many hedge funds. A relatively recent trend, both in research and industrial practice, has been
the development of increasingly sophisticated automated trading strategies. These often rely on
underlying technical analysis principles (see algorithmic trading article for an overview).

[edit]Systematic trading
[edit]Neural networks
Since the early 1990s when the first practically usable types emerged, artificial neural
networks (ANNs) have rapidly grown in popularity. They are artificial intelligence adaptive
software systems that have been inspired by how biological neural networks work. They are
used because they can learn to detect complex patterns in data. In mathematical terms, they
are universal function approximators,[22][23]meaning that given the right data and configured
correctly, they can capture and model any input-output relationships. This not only removes the
need for human interpretation of charts or the series of rules for generating entry/exit signals,
but also provides a bridge to fundamental analysis, as the variables used in fundamental
analysis can be used as input.

As ANNs are essentially non-linear statistical models, their accuracy and prediction capabilities
can be both mathematically and empirically tested. In various studies, authors have claimed that
neural networks used for generating trading signals given various technical and fundamental
inputs have significantly outperformed buy-hold strategies as well as traditional linear technical
analysis methods when combined with rule-based expert systems.[24][25][26]

While the advanced mathematical nature of such adaptive systems has kept neural networks for
financial analysis mostly within academic research circles, in recent years more user
friendly neural network software has made the technology more accessible to traders. However,
large-scale application is problematic because of the problem of matching the correct neural
topology to the market being studied.

[edit]Rule-based trading
Rule-based trading is an approach intended to create trading plans using strict and clear-cut
rules. Unlike some other technical methods and the approach of fundamental analysis, it defines
a set of rules that determine all trades, leaving minimal discretion. The theory behind this
approach is that by following a distinct set of trading rules you will reduce the number of poor
decisions, which are often emotion based.

For instance, a trader might make a set of rules stating that he will take a long position
whenever the price of a particular instrument closes above its 50-day moving average, and
shorting it whenever it drops below.

[edit]Combination with other market forecast methods

John Murphy states that the principal sources of information available to technicians are price,
volume and open interest.[27] Other data, such as indicators and sentiment analysis, are
considered secondary.
However, many technical analysts reach outside pure technical analysis, combining other
market forecast methods with their technical work. One advocate for this approach is John
Bollinger, who coined the term rational analysis in the middle 1980s for the intersection of
technical analysis and fundamental analysis.[2] Another such approach, fusion
analysis, [3] overlays fundamental analysis with technical, in an attempt to improve portfolio
manager performance.

Technical analysis is also often combined with quantitative analysis and economics. For

example, neural networks may be used to help identify intermarket relationships.[4] A few
market forecasters combine financial astrology with technical analysis. Chris Carolan's article
"Autumn Panics and Calendar Phenomenon", which won the Market Technicians Association
Dow Award for best technical analysis paper in 1998, demonstrates how technical analysis and
lunar cycles can be combined.[5] Calendar phenomena, such as the January effect in the stock
market, are generally believed to be caused by tax and accounting related transactions, and are
not related to the subject of financial astrology.

Investor and newsletter polls, and magazine cover sentiment indicators, are also used by
technical analysts.[6]

[edit]Charting terms and indicators

[edit]Types of charts

 OHLC "Bar Charts" - Open-High-Low-Close charts, also known as bar charts, plot the
span between the high and low prices of a trading period as a vertical line segment at the
trading time, and the open and close prices with horizontal tick marks on the range line,
usually a tick to the left for the open price and a tick to the right for the closing price.
 Candlestick chart - Of Japanese origin and similar to OHLC, candlesticks widen and fill
the interval between the open and close prices to emphasize the open/close relationship. In
the West, often black or red candle bodies represent a close lower than the open, while
white, green or blue candles represent a close higher than the open price.
 Line chart - Connects the closing price values with line segments.
 Point and figure chart - a chart type employing numerical filters with only passing
references to time, and which ignores time entirely in its construction.
[edit]Concepts

 Resistance - a price level which acts as a ceiling above prices

 Support - a price level which acts as a floor below prices
 Breakout - the concept whereby prices forcefully penetrate an area of
prior support or resistance, usually, but not always, accompanied by an increase in volume.
 Trending - the phenomenon by which price movement tends to persist in one direction
for an extended period of time
 Average true range - averaged daily trading range, adjusted for price gaps
 Chart pattern - distinctive pattern created by the movement of security prices on a chart
 Dead cat bounce - the phenomenon whereby a spectacular decline in the price of a
stock is immediately followed by a moderate and temporary rise before resuming its
downward movement
 Elliott wave principle and the golden ratio to calculate successive price movements and
retracements
 Momentum - the rate of price change
 Point and figure analysis - A priced-based analytical approach employing numerical
filters which may incorporate time references, though ignores time entirely in its
construction.

[edit]Overlays

Overlays are generally superimposed over the main price chart.

 Resistance - an area that brings on increased selling

 Support - an area that brings on increased buying
 Breakout - when a price passes through and stays above an area
of support or resistance
 Trend line - a sloping line of support or resistance
 Channel - a pair of parallel trend lines
 Moving average - lags behind the price action but filters
out short term movements
 Bollinger bands - a range of price volatility
 Parabolic SAR - Wilder's trailing stop based on prices tending to stay within
a parabolic curve during a strong trend
 Pivot point - derived by calculating the numerical average of a particular currency's or
stock's high, low and closing prices
 Ichimoku kinko hyo - a moving average-based system that factors in time and the
average point between a candle's high and low
[edit]Price-based indicators
These indicators are generally shown below or above the main price chart.

 Advance decline line - a popular indicator of market breadth

 Average Directional Index - a widely used indicator of trend strength
 Commodity Channel Index - identifies cyclical trends
 MACD - moving average convergence/divergence
 Relative Strength Index (RSI) - oscillator showing price strength
 Stochastic oscillator - close position within recent trading range
 Trix - an oscillator showing the slope of a triple-smoothed exponential moving average
 Momentum - the rate of price change
[edit]Volume-based indicators

 Accumulation/distribution index - based on the close within the day's range

 Money Flow - the amount of stock traded on days the price went up
 On-balance volume - the momentum of buying and selling stocks
 PAC charts - two-dimensional method for charting volume by price level
[edit]Empirical evidence
Whether technical analysis actually works is a matter of controversy. Methods vary greatly, and
different technical analysts can sometimes make contradictory predictions from the same data.
Many investors claim that they experience positive returns, but academic appraisals often find
that it has little predictive power.[28] Modern studies may be more positive: of 95 modern studies,
56 concluded that technical analysis had positive results, although data-snooping bias and other
problems make the analysis difficult.[6] Nonlinear prediction using neural networks occasionally
produces statistically significant prediction results.[29] A Federal Reserve working
paper[14] regarding support and resistance levels in short-term foreign exchange rates "offers
strong evidence that the levels help to predict intraday trend interruptions," although the
"predictive power" of those levels was "found to vary across the exchange rates and firms
examined".

Technical trading strategies were found to be effective in the Chinese marketplace by a recent
study that states, "Finally, we find significant positive returns on buy trades generated by the
contrarian version of the moving average crossover rule, the channel breakout rule, and the
Bollinger band trading rule, after accounting for transaction costs of 0.50 percent." Nauzer J.
Balsara, Gary Chen and Lin Zheng The Chinese Stock Market: An Examination of the Random
Walk Model and Technical Trading Rules [30]

Critics of technical analysis include well-known fundamental analysts. For example, Peter

Lynch once commented, "Charts are great for predicting the past."[citation needed] Warren Buffett has
said, "I realized technical analysis didn't work when I turned the charts upside down and didn't
get a different answer" and "If past history was all there was to the game, the richest people
would be librarians."[citation needed]

An influential 1992 study by Brock et al. which appeared to find support for technical trading
rules was tested for data snooping and other problems in 1999;[31] the sample covered by Brock
et al. was robust to data snooping.

Subsequently, a comprehensive study of the question by Amsterdam economist Gerwin

Griffioen concludes that: "for the U.S., Japanese and most Western European stock market
indices the recursive out-of-sample forecasting procedure does not show to be profitable, after
implementing little transaction costs. Moreover, for sufficiently high transaction costs it is found,
by estimating CAPMs, that technical trading shows no statistically significant risk-corrected out-
of-sample forecasting power for almost all of the stock market indices."[9] Transaction costs are
particularly applicable to "momentum strategies"; a comprehensive 1996 review of the data and
studies concluded that even small transaction costs would lead to an inability to capture any
excess from such strategies.[32]

In a paper published in the Journal of Finance Dr. Andrew W. Lo, director MIT Laboratory for
Financial Engineering, working with Harry Mamaysky and Jiang Wang found that "Technical
analysis, also known as "charting," has been a part of financial practice for many decades, but
this discipline has not received the same level of academic scrutiny and acceptance as more
traditional approaches such as fundamental analysis. One of the main obstacles is the highly
subjective nature of technical analysis---the presence of geometric shapes in historical price
charts is often in the eyes of the beholder. In this paper, we propose a systematic and automatic
approach to technical pattern recognition using nonparametric kernel regression, and apply this
method to a large number of U.S. stocks from 1962 to 1996 to evaluate the effectiveness of
technical analysis. By comparing the unconditional empirical distribution of daily stock returns to
the conditional distribution---conditioned on specific technical indicators such as head-and-
shoulders or double-bottoms---we find that over the 31-year sample period, several technical
indicators do provide incremental information and may have some practical value."[33] In that
same paper Dr. Lo wrote that "several academic studies suggest that...technical analysis may
well be an effective means for extracting useful information from market prices."[34] Some
techniques such as Drummond Geometry attempt to overcome the past data bias by projecting
support and resistance levels from differing time frames into the near-term future and combining
that with reversion to the mean techniques. [35]

[edit]Efficient market hypothesis

The efficient market hypothesis (EMH) contradicts the basic tenets of technical analysis by
stating that past prices cannot be used to profitably predict future prices. Thus it holds that
technical analysis cannot be effective. Economist Eugene Fama published the seminal paper on
the EMH in the Journal of Finance in 1970, and said "In short, the evidence in support of the
efficient markets model is extensive, and (somewhat uniquely in economics) contradictory
evidence is sparse."[36] EMH advocates say that if prices quickly reflect all relevant information,
no method (including technical analysis) can "beat the market." Developments which influence
prices occur randomly and are unknowable in advance. The vast majority of academic papers
find that technical trading rules, after consideration for trading costs, are not profitable.[citation needed]

Technicians say that EMH ignores the way markets work, in that many investors base their
expectations on past earnings or track record, for example. Because future stock prices can be
strongly influenced by investor expectations, technicians claim it only follows that past prices
influence future prices.[37] They also point to research in the field of behavioral finance,
specifically that people are not the rational participants EMH makes them out to be. Technicians
have long said that irrational human behavior influences stock prices, and that this behavior
leads to predictable outcomes.[38] Author David Aronson says that the theory of behavioral
finance blends with the practice of technical analysis:

By considering the impact of emotions, cognitive errors, irrational preferences, and the dynamics of group
behavior, behavioral finance offers succinct explanations of excess market volatility as well as the excess
returns earned by stale information strategies.... cognitive errors may also explain the existence of market
inefficiencies that spawn the systematic price movements that allow objective TA [technical analysis]
methods to work.[37]

EMH advocates reply that while individual market participants do not always act rationally (or
have complete information), their aggregate decisions balance each other, resulting in a rational
outcome (optimists who buy stock and bid the price higher are countered by pessimists who sell
their stock, which keeps the price in equilibrium).[39] Likewise, complete information is reflected
in the price because all market participants bring their own individual, but incomplete,
knowledge together in the market.[39]
[edit]Random walk hypothesis
The random walk hypothesis may be derived from the weak-form efficient markets hypothesis,
which is based on the assumption that market participants take full account of any information
contained in past price movements (but not necessarily other public information). In his book A
Random Walk Down Wall Street, Princeton economist Burton Malkiel said that technical
forecasting tools such as pattern analysis must ultimately be self-defeating: "The problem is that
once such a regularity is known to market participants, people will act in such a way that
prevents it from happening in the future."[40] In a 1999 response to Malkiel, Andrew Lo and Craig
McKinlay collected empirical papers that questioned the hypothesis' applicability[41] that
suggested a non-random and possibly predictive component to stock price movement, though
they were careful to point out that rejecting random walk does not necessarily invalidate EMH.

Technicians say the EMH and random walk theories both ignore the realities of markets, in that
participants are not completely rational and that current price moves are not independent of
previous moves.[21][42] Critics reply that one can find virtually any chart pattern after the fact, but
that this does not prove that such patterns are predictable. Technicians maintain that both
theories would also invalidate numerous other trading strategies such as index
arbitrage, statistical arbitrage and many other trading systems.[37]
TEchnical analysis and fundamental analysis are the two main schools of thought in the financial markets.
As we've mentioned, technical analysis looks at the price movement of a security and uses this data to
predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors,
known as fundamentals. Let's get into the details of how these two approaches differ, the criticisms against
technical analysis and how technical and fundamental analysis can be used together to analyze securities.  
he Differences 
Charts vs. Financial Statements 
At the most basic level, a technical analyst approaches a security from the charts, while a
fundamental analyst starts with the financial statements. (For further reading, see Introduction To
Fundamental Analysis and Advanced Financial Statement Analysis.) 

By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst

tries to determine a company's value. In financial terms, an analyst attempts to measure a
company's intrinsic value. In this approach, investment decisions are fairly easy to make - if the
price of a stock trades below its intrinsic value, it's a good investment. Although this is an
oversimplification (fundamental analysis goes beyond just the financial statements) for the
purposes of this tutorial, this simple tenet holds true. 

Technical traders, on the other hand, believe there is no reason to analyze a company's
fundamentals because these are all accounted for in the stock's price. Technicians believe that all
the information they need about a stock can be found in its charts. 

Time Horizon 
Fundamental analysis takes a relatively long-term approach to analyzing the market compared to
technical analysis. While technical analysis can be used on a timeframe of weeks, days or even
minutes, fundamental analysis often looks at data over a number of years. 

The different timeframes that these two approaches use is a result of the nature of the investing
style to which they each adhere. It can take a long time for a company's value to be reflected in
the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until
the stock's market price rises to its "correct" value. This type of investing is called value
investing and assumes that the short-term market is wrong, but that the price of a particular stock
will correct itself over the long run. This "long run" can represent a timeframe of as long as
several years, in some cases. (For more insight, read Warren Buffett: How He Does It and What Is
Warren Buffett's Investing Style?) 

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of
time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a
daily basis like price and volume information. Also remember that fundamentals are the actual
characteristics of a business. New management can't implement sweeping changes overnight and
it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason
that fundamental analysts use a long-term timeframe, therefore, is because the data they use to
analyze a stock is generated much more slowly than the price and volume data used by technical
analysts. 
Trading Versus Investing 
Not only is technical analysis more short term in nature that fundamental analysis, but the goals
of a purchase (or sale) of a stock are usually different for each approach. In general, technical
analysis is used for a trade, whereas fundamental analysis is used to make an investment.
Investors buy assets they believe can increase in value, while traders buy assets they believe they
can sell to somebody else at a greater price. The line between a trade and an investment can be
blurry, but it does characterize a difference between the two schools. 

The Critics 
Some critics see technical analysis as a form of black magic. Don't be surprised to see them
question the validity of the discipline to the point where they mock its supporters. In fact,
technical analysis has only recently begun to enjoy some mainstream credibility. While most
analysts on Wall Street focus on the fundamental side, just about any major brokerage now
employs technical analysts as well. 

Much of the criticism of technical analysis has its roots in academic theory - specifically
the efficient market hypothesis(EMH). This theory says that the market's price is always the correct
one - any past trading information is already reflected in the price of the stock and, therefore, any
analysis to find undervalued securities is useless.  

There are three versions of EMH. In the first, called weak form efficiency, all past price information
is already included in the current price. According to weak form efficiency, technical
analysis can't predict future movements because all past information has already been accounted
for and, therefore, analyzing the stock's past price movements will provide no insight into its
future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed
to be of little use in finding investment opportunities. The third is strong form efficiency, which
states that all information in the market is accounted for in a stock's price and neither
technical nor fundamental analysis can provide investors with an edge. The vast majority of
academics believe in at least the weak version of EMH, therefore, from their point of view, if
technical analysis works, market efficiency will be called into question. (For more insight,
read What Is Market Efficiency? and Working Through The Efficient Market Hypothesis.) 

There is no right answer as to who is correct. There are arguments to be made on both sides and,
therefore, it's up to you to do the homework and determine your own philosophy. 

Can They Co-Exist? 

Although technical analysis and fundamental analysis are seen by many as polar opposites - the
oil and water of investing - many market participants have experienced great success by
combining the two. For example, some fundamental analysts use technical analysis techniques to
figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs
when the security is severely oversold. By timing entry into a security, the gains on the investment
can be greatly improved. 

Alternatively, some technical traders might look at fundamentals to add strength to a technical
signal. For example, if a sell signal is given through technical patterns and indicators, a technical
trader might look to reaffirm his or her decision by looking at some key fundamental data.
Oftentimes, having both the fundamentals and technicals on your side can provide the best-case
 scenario for a trade. 

While mixing some of the components of technical and fundamental analysis is not well received
by the most devoted groups in each school, there are certainly benefits to at least understanding
both schools of thought. 

Technical Analysis: The Use Of Trend

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By Cory Janssen, Chad Langager and Casey Murphy

One of the most important concepts in technical analysis is that of trend. The meaning in finance isn't all
that different from the general definition of the term - a trend is really nothing more than the general
direction in which a security or market is headed. Take a look at the chart below: 

Figure 1

It isn't hard to see that the trend in Figure 1 is up. However, it's not always this easy to see a trend: 
 Figure 2

There are lots of ups and downs in this chart, but there isn't a clear indication of which direction this
security is headed. 

A More Formal Definition 

Unfortunately, trends are not always easy to see. In other words, defining a trend goes well beyond the
obvious. In any given chart, you will probably notice that prices do not tend to move in a straight line in
any direction, but rather in a series of highs and lows. In technical analysis, it is the movement of the
highs and lows that constitutes a trend. For example, an uptrend is classified as a series of higher highs
and higher lows, while a downtrend is one of lower lows and lower highs. 

Figure 3

Figure 3 is an example of an uptrend. Point 2 in the chart is the first high, which is determined after the
price falls from this point. Point 3 is the low that is established as the price falls from the high. For this to
remain an uptrend, each successive low must not fall below the previous lowest point or the trend is
deemed a reversal.   
Types of Trend 
There are three types of trend: 
 Uptrends
 Downtrends 
 Sideways/Horizontal Trends As the names imply, when each successive peak and trough is
higher, it's referred to as an upward trend. If the peaks and troughs are getting lower, it's a
downtrend. When there is little movement up or down in the peaks and troughs, it's a sideways or
horizontal trend. If you want to get really technical, you might even say that a sideways trend is
actually not a trend on its own, but a lack of a well-defined trend in either direction. In any case,
the market can really only trend in these three ways: up, down or nowhere. (For more insight,
see Peak-And-Trough Analysis.) 

Trend Lengths 
Along with these three trend directions, there are three trend classifications. A trend of any
direction can be classified as a long-term trend, intermediate trend or a short-term trend. In terms
of the stock market, a major trend is generally categorized as one lasting longer than a year. An
intermediate trend is considered to last between one and three months and a near-term trend is
anything less than a month. A long-term trend is composed of several intermediate trends, which
often move against the direction of the major trend. If the major trend is upward and there is a
downward correction in price movement followed by a continuation of the uptrend, the correction
is considered to be an intermediate trend. The short-term trends are components of both major
and intermediate trends. Take a look a Figure 4 to get a sense of how these three trend lengths
might look. 

Figure 4

When analyzing trends, it is important that the chart is constructed to best reflect the type of trend
 being analyzed. To help identify long-term trends, weekly charts or daily charts spanning a five-
year period are used by chartists to get a better idea of the long-term trend. Daily data charts are
best used when analyzing both intermediate and short-term trends. It is also important to
remember that the longer the trend, the more important it is; for example, a one-month trend is
not as significant as a five-year trend. (To read more, seeShort-, Intermediate- And Long-Term
Trends.) 

Trend lines 
A trend line is a simple charting technique that adds a line to a chart to represent the trend in the
market or a stock. Drawing a trendline is as simple as drawing a straight line that follows a
general trend. These lines are used to clearly show the trend and are also used in the
identification of trend reversals. 

As you can see in Figure 5, an upward trendline is drawn at the lows of an upward trend. This line
represents the support the stock has every time it moves from a high to a low. Notice how the
price is propped up by this support. This type of trendline helps traders to anticipate the point at
which a stock's price will begin moving upwards again. Similarly, a downward trendline is drawn
at the highs of the downward trend. This line represents the resistance level that a stock faces
every time the price moves from a low to a high. (To read more, see Support & Resistance
Basics and Support And Resistance Zones - Part 1 and Part 2.) 

Figure 5


Channels 
A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of
 support and resistance. The upper trend line connects a series of highs, while the lower trendline
connects a series of lows. A channel can slope upward, downward or sideways but, regardless of
the direction, the interpretation remains the same. Traders will expect a given security to trade
between the two levels of support and resistance until it breaks beyond one of the levels, in which
case traders can expect a sharp move in the direction of the break. Along with clearly displaying
the trend, channels are mainly used to illustrate important areas of support and resistance. 

Figure 6


Figure 6 illustrates a descending channel on a stock chart; the upper trendline has been placed
on the highs and the lower trendline is on the lows. The price has bounced off of these lines
several times, and has remained range-bound for several months. As long as the price does not
fall below the lower line or move beyond the upper resistance, the range-bound downtrend is
expected to continue. 

The Importance of Trend 

It is important to be able to understand and identify trends so that you can trade with rather than
against them. Two important sayings in technical analysis are "the trend is your friend" and "don't
buck the trend," illustrating how important trend analysis is for technical traders. 
 Technical Analysis: Support And Resistance

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By Cory Janssen, Chad Langager and Casey Murphy

Once you understand the concept of a trend, the next major concept is that of support and resistance.
You'll often hear technical analysts talk about the ongoing battle between the bulls and the bears, or the
struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom
moves above (resistance) or below (support). 

Figure 1

As you can see in Figure 1, support is the price level through which a stock or market seldom falls
(illustrated by the blue arrows). Resistance, on the other hand, is the price level that a stock or market
seldom surpasses (illustrated by the red arrows). 

Why Does it Happen? 

These support and resistance levels are seen as important in terms of market psychology and supply and
demand. Support and resistance levels are the levels at which a lot of traders are willing to buy the stock
(in the case of a support) or sell it (in the case of resistance). When these trendlines are broken, the
supply and demand and the psychology behind the stock's movements is thought to have shifted, in
which case new levels of support and resistance will likely be established. 

Round Numbers and Support and Resistance 

One type of universal support and resistance that tends to be seen across a large number of securities is
round numbers. Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be important in support and
resistance levels because they often represent the major psychological turning points at which many
traders will make buy or sell decisions. 

Buyers will often purchase large amounts of stock once the price starts to fall toward a major round
number such as $50, which makes it more difficult for shares to fall below the level. On the other hand,
sellers start to sell off a stock as it moves toward a round number peak, making it difficult to move past
this upper level as well. It is the increased buying and selling pressure at these levels that makes them
important points of support and resistance and, in many cases, major psychological points as well. 

Role Reversal 
Once a resistance or support level is broken, its role is reversed. If the price falls below a support level,
that level will become resistance. If the price rises above a resistance level, it will often become support.
As the price moves past a level of support or resistance, it is thought that supply and demand has shifted,
causing the breached level to reverse its role. For a true reversal to occur, however, it is important that
the price make a strong move through either the support or resistance. (For further reading,
see Retracement Or Reversal: Know The Difference.) 

Figure 2

For example, as you can see in Figure 2, the dotted line is shown as a level of resistance that has
prevented the price from heading higher on two previous occasions (Points 1 and 2). However, once the
resistance is broken, it becomes a level of support (shown by Points 3 and 4) by propping up the price
and preventing it from heading lower again. 

Many traders who begin using technical analysis find this concept hard to believe and don't realize that
this phenomenon occurs rather frequently, even with some of the most well-known companies. For
example, as you can see in Figure 3, this phenomenon is evident on the Wal-Mart Stores Inc. (WMT)
chart between 2003 and 2006. Notice how the role of the $51 level changes from a strong level of support
to a level of resistance. 
 Figure 3

In almost every case, a stock will have both a level of support and a level of resistance and will trade in
this range as it bounces between these levels. This is most often seen when a stock is trading in a
generally sideways manner as the price moves through successive peaks and troughs, testing resistance
and support. 

The Importance of Support and Resistance 

Support and resistance analysis is an important part of trends because it can be used to make trading
decisions and identify when a trend is reversing. For example, if a trader identifies an important level of
resistance that has been tested several times but never broken, he or she may decide to take profits as
the security moves toward this point because it is unlikely that it will move past this level. 

Support and resistance levels both test and confirm trends and need to be monitored by anyone who
uses technical analysis. As long as the price of the share remains between these levels of support and
resistance, the trend is likely to continue. It is important to note, however, that a break beyond a level of
support or resistance does not always have to be a reversal. For example, if prices moved above the
resistance levels of an upward trending channel, the trend has accelerated, not reversed. This means that
the price appreciation is expected to be faster than it was in the channel. 

Being aware of these important support and resistance points should affect the way that you trade a
stock. Traders should avoid placing orders at these major points, as the area around them is usually
marked by a lot of volatility. If you feel confident about making a trade near a support or resistance level, it
is important that you follow this simple rule: do not place orders directly at the support or resistance level.
This is because in many cases, the price never actually reaches the whole number, but flirts with it
instead. So if you're bullish on a stock that is moving toward an important support level, do not place the
trade at the support level. Instead, place it above the support level, but within a few points. On the other
hand, if you are placing stops or short selling, set up your trade price at or below the level of support. 
 Technical Analysis: The Importance Of Volume

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By Cory Janssen, Chad Langager and Casey Murphy

To this point, we've only discussed the price of a security. While price is the primary item of concern in
technical analysis, volume is also extremely important. 

What is Volume? 
Volume is simply the number of shares or contracts that trade over a given period of time, usually a day.
The higher the volume, the more active the security. To determine the movement of the volume (up or
down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume bars
illustrate how many shares have traded per period and show trends in the same way that prices do. (For
further reading, see Price Patterns - Part 3, Gauging Support And Resistance With Price By Volume.)  

Why Volume is Important 

Volume is an important aspect of technical analysis because it is used to confirm trends and chart
patterns. Any price movement up or down with relatively high volume is seen as a stronger, more relevant
move than a similar move with weak volume. Therefore, if you are looking at a large price movement, you
should also examine the volume to see whether it tells the same story. 
Say, for example, that a stock jumps 5% in one trading day after being in a long downtrend. Is this a sign
of a trend reversal? This is where volume helps traders. If volume is high during the day relative to the
average daily volume, it is a sign that the reversal is probably for real. On the other hand, if the volume
is below average, there may not be enough conviction to support a true trend reversal. (To read more,
check out Trading Volume - Crowd Psychology.) 

Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and
vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is
usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days
are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end. 

When volume tells a different story, it is a case of divergence, which refers to a contradiction between two
different indicators. The simplest example of divergence is a clear upward trend on declining volume. (For
additional insight, read Divergences, Momentum And Rate Of Change.) 

Volume and Chart Patterns 

The other use of volume is to confirm chart patterns. Patterns such as head and
shoulders, triangles, flags and other price patterns can be confirmed with volume, a process which we'll
describe in more detail later in this tutorial. In most chart patterns, there are several pivotal points that are
vital to what the chart is able to convey to chartists. Basically, if the volume is not there to confirm the
pivotal moments of a chart pattern, the quality of the signal formed by the pattern is weakened. 

Volume Precedes Price 

Another important idea in technical analysis is that price is preceded by volume. Volume is closely
monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to
decrease in an uptrend, it is usually a sign that the upward run is about to end. 

Now that we have a better understanding of some of the important factors of technical analysis, we can
move on to charts, which help to identify trading opportunities in prices movements. 
 Technical Analysis: What Is A Chart?

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In technical analysis, charts are similar to the charts that you see in any business setting. A chart is
simply a graphical representation of a series of prices over a set time frame. For example, a chart may
show a stock's price movement over a one-year period, where each point on the graph represents
the closing price for each day the stock is traded: 

Figure 1

Figure 1 provides an example of a basic chart. It is a representation of the price movements of a stock
over a 1.5 year period. The bottom of the graph, running horizontally (x-axis), is the date or time scale. On
the right hand side, running vertically (y-axis), the price of the security is shown. By looking at the graph
we see that in October 2004 (Point 1), the price of this stock was around $245, whereas in June 2005
(Point 2), the stock's price is around $265. This tells us that the stock has risen between October 2004
and June 2005. 

Chart Properties 
There are several things that you should be aware of when looking at a chart, as these factors can affect
the information that is provided. They include the time scale, the price scale and the price point properties
used. 
The Time Scale 
The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to
seconds. The most frequently used time scales are intraday, daily, weekly, monthly, quarterly and
annually. The shorter the time frame, the more detailed the chart. Each data point can represent the
closing price of the period or show the open, the high, the low and the close depending on the chart
used. 

Intraday charts plot price movement within the period of one day. This means that the time scale could be
as short as five minutes or could cover the whole trading day from the opening bell to the closing bell. 

Daily charts are comprised of a series of price movements in which each price point on the chart is a full
day’s trading condensed into one point. Again, each point on the graph can be simply the closing price or
can entail the open, high, low and close for the stock over the day. These data points are spread out over
weekly, monthly and even yearly time scales to monitor both short-term and intermediate trends in price
movement. 

Weekly, monthly, quarterly and yearly charts are used to analyze longer term trends in the movement of a
stock's price. Each data point in these graphs will be a condensed version of what happened over the
specified period. So for a weekly chart, each data point will be a representation of the price movement of
the week. For example, if you are looking at a chart of weekly data spread over a five-year period and
each data point is the closing price for the week, the price that is plotted will be the closing price on the
last trading day of the week, which is usually a Friday. 

The Price Scale and Price Point Properties 

The price scale is on the right-hand side of the chart. It shows a stock's current price and compares it to
past data points. This may seem like a simple concept in that the price scale goes from lower prices to
higher prices as you move along the scale from the bottom to the top. The problem, however, is in the
structure of the scale itself. A scale can either be constructed in a linear (arithmetic) or logarithmic way,
and both of these options are available on most charting services. 

If a price scale is constructed using a linear scale, the space between each price point (10, 20, 30, 40) is
separated by an equal amount. A price move from 10 to 20 on a linear scale is the same distance on the
chart as a move from 40 to 50. In other words, the price scale measures moves in absolute terms and
does not show the effects of percent change. 
Figure 2

If a price scale is in logarithmic terms, then the distance between points will be equal in terms of percent
change. A price change from 10 to 20 is a 100% increase in the price while a move from 40 to 50 is only a
25% change, even though they are represented by the same distance on a linear scale. On a logarithmic
scale, the distance of the 100% price change from 10 to 20 will not be the same as the 25% change from
40 to 50. In this case, the move from 10 to 20 is represented by a larger space one the chart, while the
move from 40 to 50, is represented by a smaller space because, percentage-wise, it indicates a smaller
move. In Figure 2, the logarithmic price scale on the right leaves the same amount of space between 10
and 20 as it does between 20 and 40 because these both represent 100% increases.