What is Technical Analysis

By visiting this web site, there is very good chance that you already use technical analysis in your investment decision making process. However, it is always worth re-evaluating your tools, by taking a moment to consider the nature of technical analysis and how we might use it.

What isTechnical Analysis?  

Quite simply, technical analysis is the study of in vestor be havIour and its effect on the subsequent price action of financial in struments. The main data that we need to perform our studies are the price histories of the instruments, together with time and volume information. These enable us to form our views, based on objective facts.  Technical Analysis versus Fundamental Analysis  Fundamental

Analysis concerns itself with establishing the value of stocks and other

instruments. 

The fundamental analyst will concern himself with

complex inter-relationships of financial statements, demand forecasts,quality of management, earnings and growth, etc. Hewill then make a judgement on the share, commodity, or other financial instrument, often relative to its sector or market peers and form a judgement whether it is over- or under-valued. 

The majority of stock research from brokers or investment banks

will be base don company

fundamentals. 

At Investors Intelligence, while

we admire much of this work we take a more

pragmatic a pproach; we monitor and analyse the ways in which in vestors interpret this mass of fundamental data and how they then be have. 

This be have our is collectively called sentiment.

Our view is that investor sentiment is the single most important factor in determining an instrument is price.

We believe that technical analysis holds the key to monitoring investor sentiment. 

Some investors and market "experts" believe that fundamental analysis and technical analysis are mutually exclusive.

 We disagree.

 We think they are highly complementary and should work together to tell you what to buy or sell and when to buy or sell. Many successful traders use acombination of fundamental stock selection procedures and technical analysis timing filters with excellent results. Brief history It is probably reasonable to assume that where commerce has flourished in civilisations so have the traders who have paid close attention to prices and their movements. 

However,rather than dwell upon the wonders of the Phoenician market for o live oil forwards, or the ancient Japanese and Chinese history of rice trading, our story starts with one Charles Dow,inventor of the first stock market index in 1884.

Charles Dow invented point and figure charting after he noticed that by the time important corporate news entered the public domain, the

share price had already moved, due not least to insider trading.  Therefore he watched the open outcry " curb market ", writing down

 prices in a notebook, looking for clues to trending market action.  Finding a page of price changes confusing, not surprisingly, he decided

 to plot price action in graphic form.

Mr Dow also wrote as eries of articles for the Wall Street Journal in the latter years of the 19th century.

 This body of work became known as "Dow Theory" and formed the initial basis for what we know as technical analysis today. 

While we will not dwell on the finer details of Dow Theory in this section, the most important concepts that Mr Dow recognised were that prices reflect the current balance of supply and demand (i.e. the hopes and fears of investor). And most importantly, an imbalance of supply and demand causes prices to form recognisable trends,up and down. 

Certainly, the concept of studying price action was fairly well establishe

d by the early 20 th century. By the 1940s to 1950s additional pioneers of technical analysis such as Bill Jiler ,Robert Edwares, John Magee, Alexander Wheel an and Abe Cohen were making

steady progress, not only in the types of charts used to depict trends,but also techniques for analysing price action. 

However the acceleration in technical research techniques commenced in the late 1970s with the introduction of computers. 

This made it possible for hypotheses and indicators to be calculate

d and back tested as to their efficacy.  While this has greatly expanded t

he body of the or etical work available on price studies, many seasoned chart readers maintain that at least 90 percent of what they need to know about prices is revealed by the price action alone.

Types of charts There are many ways to display price charts. Each has its own benefits,but at the end of the day it is up to the individual to decide which provides the clearest visual picture and is likely to be of most in identifying trends at an early stage.

 We will look at the most popular four types used by subscribers to

 Investors Intelligence:

Line Charts .

This is the simplest chart format and is generated by using a line to join the data points. The most common use for line charts is for indicators that only have a single daily value(rather than high/low) such as momentum or moving averages. 

Bar Charts As their name suggests, bar charts use vertical bars to represent price action for that day,drawn from the lowest price to the highest price. 

What is Technical AnalysisThe daily line chart is perhaps the simplest of charts available, show in gonly the closing price of each day.

Bar Chart

s As their name suggests, bar charts use vertical bars to represent price action for that day,drawn from the lowest price to the highest price. 

 One of the advantages of bar charts is that a longer time period can be viewed by changing the scale from daily to weekly or monthly bars. 

This is a daily "HLC" bar chart:

 each bar showing the day Is "high", "low" and "close" prices.The period viewed is 6 months from

November 2003 to April, 2004.  

 This is a weekly bar chart:each bar showing the weekly high, low and close. The period covered is two years, from April, 2002 to April, 2004, and shows the movement in the daily

chart (bottom right area)in its longer term con text

Candle stick Charts Candlestick charts provide a more

sophisticated visual representation of bar charts. 

The opening price is included in the chart and a day is activity would be represented as follows:  

 Candlestick charts are generally plotted over a one

-day period but technical analysts also use weekly and monthly candlestick charts to provide a valuable picture of the longer-term price

action. 

Candlestick charting is one of the oldest methods of technical analysis, with both Japanese and Chinese both claiming that rice traders were u

sing candlestick charts over 4000 years ago, although this is not proven. Its a ppeallies in its ability to give a clear visualre presentation of the price action during a period, leading to easy-to-recognise pattern recognition.  

 The candle chart displays a wealth of price in formation, with open,high, low and close

Point & Figure Charts

 have a devoted following, particularly amongst Wall Street operators.They are unique in sever always

:a) They haveno time scale, only registering changes when significant price action occurs.

b) P&F charts box scale serves as a "noisereduction"system there by eliminating minor movements so that the primary trend characteristics are revealed to the user. 

c) They quickly filter out the most consistently trending stocks or financial in struments from erratic and trend-less ones. 

Areas of congestion on the charts define the key areas of supply and demand for a security(commonly known as support and resistance). 

... The p&f chart differs from the previous two charts in that it displays price data without any time input,giving an accurate depiction of trend.