What is technical analysis?
Technical analysis is the study of financial market action. The technician looks at price changes that
occur on a day-to-day or week-to-week basis or over any other constant time period displayed in
graphic form, called charts. Hence the name chart analysis.
A chartist analyzes price charts only, while the technical analyst studies technical indicators derived
from price changes in addition to the price charts.
Technical analysts examine the price action of the financial markets instead of the fundamental fac-
tors that (seem to) effect market prices. Technicians believe that even if all relevant information of a
particular market or stock was available, you still could not predict a precise market "response" to that
information. There are so many factors interacting at any one time that it is easy for important ones
to be ignored in favor of those that are considered as the "flavor of the day."
The technical analyst believes that all the relevant market information is reflected (or discounted) in
the price with the exception of shocking news such as natural distasters or acts of God. These fac-
tors, however, are discounted very quickly.
Watching financial markets, it becomes obvious that there are trends, momentum and patterns that
repeat over time, not exactly the same way but similar. Charts are self-similar as they show the same
fractal structure (a fractal is a tiny pattern; self-similar means the overall pattern is made up of smaller
versions of the same pattern) whether in stocks, commodities, currencies, bonds. A chart is a mirror
of the mood of the crowd and not of the fundamental factors. Thus, technical analysis is the
analysis of human mass psychology. Therefore, it is also called behavioral finance.
Technical analysis pre-empts fundamental data
Fundamentalists believe there is a cause and effect between fundamental factors and price changes.
This means, if the fundamental news is positive the price should rise, and if the news is negative the
price should fall. However, long-term analyses of price changes in financial markets around the world
show that such a correlation is present only in the short-term horizon and only to a limited extent. It is
non-existent on a medium- and long-term basis.
In fact, the contrary is true. The stock market itself is the best predictor of the future fundamental
trend. Most often, prices start rising in a new bull trend while the economy is still in recession (position
B on chart shown above), i.e. while there is no cause for such an uptrend. Vice versa, prices start
falling in a new bear trend while the economy is still growing (position A), and not providing fundamen-
tal reasons to sell. There is a time-lag of several months by which the fundamental trend follows the
stock market trend. Moreover, this is not only true for the stock market and the economy, but also for
the price trends of individual equities and company earnings. Stock prices peak ahead of peak earn-
ings while bottoming ahead of peak losses.
The purpose of technical analysis is to identify trend changes that precede the fundamental
trend and do not (yet) make sense if compared to the concurrent fundamental trend.