Technical Analysis

Definition

Technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and trading volume, in an effort to determine probable future prices.

5 Must Know Facts For Your Next Test

1. Technical analysis focuses on market action, including price and volume, to identify patterns and trends that can be used to predict future price movements.
2. Technical analysts believe that all relevant information is already reflected in a security's price, making the study of price charts and patterns more important than the fundamental analysis of a company's financials.
3. Charting is a core component of technical analysis, allowing traders to visually identify support and resistance levels, trends, and potential reversal points.
4. Technical indicators, such as moving averages, oscillators, and momentum indicators, are used to supplement chart analysis and provide additional insights into market sentiment and future price direction.
5. Technical analysis is widely used in the context of efficient markets, as it assumes that all publicly available information is already reflected in a security's price, and that future price movements can be predicted based on historical patterns.

Review Questions

• Explain how technical analysis is used to evaluate market value ratios.
  • Technical analysis can be used to complement the evaluation of market value ratios, such as price-to-earnings (P/E) and price-to-book (P/B) ratios. By analyzing historical price and volume data, technical analysts can identify support and resistance levels, trends, and potential reversal points that may influence the future valuation of a security. This information can be used in conjunction with fundamental analysis of a company's financial ratios to make more informed investment decisions.
• Describe how the principles of technical analysis relate to the concept of efficient markets.
  • The efficient market hypothesis suggests that all publicly available information is already reflected in a security's price, making it impossible to consistently outperform the market through the use of fundamental analysis. Technical analysis, on the other hand, assumes that market participants' behavior and the resulting price movements can be used to predict future price trends, even in an efficient market. Technical analysts believe that by identifying patterns and trends in historical price and volume data, they can make informed decisions about the future direction of a security's price, despite the efficient market hypothesis.
• Analyze how technical analysis can be used to understand the historical picture of returns to stocks.
  • Technical analysis can provide valuable insights into the historical picture of returns to stocks by examining the patterns and trends in a security's price movements over time. By identifying support and resistance levels, trendlines, and potential reversal points, technical analysts can better understand the factors that have influenced a stock's past performance and use this information to make more informed predictions about its future returns. Additionally, the use of technical indicators, such as moving averages and oscillators, can help identify overbought or oversold conditions, which may signal potential changes in the direction of a stock's price and its future returns.

Related terms

Charting: The process of graphically depicting the historical price movements of a security, used to identify patterns and trends in the market.

Indicators: Mathematical calculations based on a security's price and/or volume that are used to help identify entry and exit points for trading.

Trend Analysis: The examination of a security's historical price movements to determine its current direction and the probability of that direction continuing.