Technical Analysis is a method for
choosing investments that relies upon
examination of the security's price history via its chart. Those who use technical analysis are often called chartists because of this fact.
In technical analysis, the investor attempts to gauge the future movement of a stock's price based on how it has behaved in the past, and how those behaviors compare to similar behavior in many other stocks over a long period of time. The
theory is that investors tend to react in similar ways to similar situations and thus the price of the stock will react in a common way as well.
Technical analysis usually takes place in two basic ways.
In one method, the
chartist looks at a stock's price movement chart and attempts to spot a
familiar pattern. If such a pattern can be found, the
chartist can then
analyze what kind of price movement that pattern has led to in the past. For example, if a certain pattern is usually followed by an upward price movement, then the investor might look to buy the stock or take another bullish position. In contrast, if the pattern typically leads to a downward price trend in the stock, then the investor would look to sell the stock or take a bearish position using options or other instruments.
In the second method, the
chartist looks for
trendlines which
delineated the price range the stock has been trading in over a specific period of time. Typically, a stock will continue to trade within this range until a "breakout" is established. One a breakout occurs, the stock will typically continue to move in that same direction until a new trading range is established. Chartists are particularly
interested in breakouts that occur on high volume because this is an indicator of a "real" breakout and not just a short-term price fluctuation.
While these two methods sound basic, implementing them is much more complex. There are hundreds of trading patterns that have been identified and the trader must determine which pattern applies and how likely it is to be accurate.
Identifying breakouts requires understanding support and resistance as well as other statistical metrics such as momentum and oscillators. We'll cover these more complex topics in later posts.
