Learning objectives

After studying this chapter the student should be able to understand:
• The basis of technical analysis
• The strengths and weaknesses of technical analysis

1.1 What is Technical Analysis?

Technical Analysis can be defined as an art and science of forecasting future prices based on an examination of the past price movements. Technical analysis is not astrology for predicting prices. Technical analysis is based on analyzing current demand-supply of commodities, stocks, indices, futures or any tradable instrument.

Technical analysis involve putting stock information like prices, volumes and open interest on a chart and applying various patterns and indicators to it in order to assess the future price movements. The time frame in which technical analysis is applied may range from intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data to many years.

There are essentially two methods of analyzing investment opportunities in the security market viz fundamental analysis and technical analysis. You can use fundamental information like financial and non-financial aspects of the company or technical information which ignores fundamentals and focuses on actual price movements.

The basis of Technical Analysis

What makes Technical Analysis an effective tool to analyze price behavior is explained by following theories given by Charles Dow:

• Price discounts everything
• Price movements are not totally random
• What is more important than why