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Introduction

Terminology
Technical Analysis
Price fields
Charts
Support & resistance
Trends
Moving averages
Indicators
Market indicators
Line studies
Periodicity
The time element

Reference

Reference
Absolute Breadth Index
Accumulation/Distribution
Accumulation Swing Index
Advance/Decline Line
Advance/Decline Ratio
Advancing-Declining Issues
Advancing, Declining, Unchanged Volume
Andrews' Pitchfork
Arms Index
Average True Range
Bollinger Bands
Breadth Thrust
Bull/Bear Ratio
Candlesticks, Japanese
CANSLIM
Chaikin Oscillator
Commodity Channel Index
Commodity Selection Index
Correlation Analysis
Cumulative Volume Index
Cycles
Demand Index
Detrended Price Oscillator
Directional Movement
Dow Theory
Ease of Movement
Efficient Market Theory
Elliott Wave Theory
Envelopes (trading bands)
Equivolume
Fibonacci Studies
Four Percent Model
Fourier Transform
Fundamental Analysis
Gann Angles
Herrick Payoff Index
Interest Rates
Kagi
Large Block Ratio
Linear Regression Lines
MACD
Mass Index
McClellan Oscillator
McClellan Summation Index
Median Price
Member Short Ratio
Momentum
Money Flow Index
Moving Averages
Negative Volume Index
New Highs-Lows Cumulative
New Highs-New Lows
New Highs/Lows Ratio
Odd Lot Balance Index
Odd Lot Purchases/Sales
Odd Lot Short Ratio
On Balance Volume
Open Interest
Open-10 TRIN
Option Analysis
Overbought/Oversold
Parabolic SAR
Patterns
Percent Retracement
Performance
Point & Figure
Positive Volume Index
Price and Volume Trend
Price Oscillator
Price Rate-of-Change
Public Short Ratio
Puts/Calls Ratio
Quadrant Lines
Relative Strength, Comparative
Relative Strength Index
Renko
Speed Resistance Lines
Spreads
Standard Deviation
STIX
Stochastic Oscillator
Swing Index
Three Line Break
Time Series Forecast
Tirone Levels
Total Short Ratio
Trade Volume Index
Trendlines
TRIX
Typical Price
Ultimate Oscillator
Upside/Downside Ratio
Upside-Downside Volume
Vertical Horizontal Filter
Volatility, Chaikin's
Volume
Volume Oscillator
Volume Rate-of-Change
Weighted Close
Williams' Accumulation/Distribution
Williams' %R
Zig Zag
Bibliography

Technical Analysis from A to Z - Introduction

Technical analysis

Should I buy today? What will prices be tomorrow, next week, or next year? Wouldn't investing be easy if we knew the answers to these seemingly simple questions? Alas, if you are reading this book in the hope that technical analysis has the answers to these questions, I'm afraid I have to disappoint you early--it doesn't. However, if you are reading this book with the hope that technical analysis will improve your investing, I have good news--it will!

Some history

The term "technical analysis" is a complicated sounding name for a very basic approach to investing. Simply put, technical analysis is the study of prices, with charts being the primary tool.

The roots of modern-day technical analysis stem from the Dow Theory, developed around 1900 by Charles Dow. Stemming either directly or indirectly from the Dow Theory, these roots include such principles as the trending nature of prices, prices discounting all known information, confirmation and divergence, volume mirroring changes in price, and support/resistance. And of course, the widely followed Dow Jones Industrial Average is a direct offspring of the Dow Theory.

Charles Dow's contribution to modern-day technical analysis cannot be understated. His focus on the basics of security price movement gave rise to a completely new method of analyzing the markets.

The human element

The price of a security represents a consensus. It is the price at which one person agrees to buy and another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to fall, he will sell it. These simple statements are the cause of a major challenge in forecasting security prices, because they refer to human expectations. As we all know firsthand, humans are not easily quantifiable nor predictable. This fact alone will keep any mechanical trading system from working consistently.

Because humans are involved, I am sure that much of the world's investment decisions are based on irrelevant criteria. Our relationships with our family, our neighbors, our employer, the traffic, our income, and our previous success and failures, all influence our confidence, expectations, and decisions.

Security prices are determined by money managers and home managers, students and strikers, doctors and dog catchers, lawyers and landscapers, and the wealthy and the wanting. This breadth of market participants guarantees an element of unpredictability and excitement.

Fundamental analysis

If we were all totally logical and could separate our emotions from our investment decisions, then, fundamental analysis the determination of price based on future earnings, would work magnificently. And since we would all have the same completely logical expectations, prices would only change when quarterly reports or relevant news was released. Investors would seek "overlooked" fundamental data in an effort to find undervalued securities.

The hotly debated "efficient market theory" states that security prices represent everything that is known about the security at a given moment. This theory concludes that it is impossible to forecast prices, since prices already reflect everything that is currently known about the security.

The future can be found in the past

If prices are based on investor expectations, then knowing what a security should sell for (i.e., fundamental analysis) becomes less important than knowing what other investors expect it to sell for. That's not to say that knowing what a security should sell for isn't important--it is. But there is usually a fairly strong consensus of a stock's future earnings that the average investor cannot disprove.

"I believe the future is only the past again, entered through another gate."
- Sir Arthur Wing Pinero, 1893

Technical analysis is the process of analyzing a security's historical prices in an effort to determine probable future prices. This is done by comparing current price action (i.e., current expectations) with comparable historical price action to predict a reasonable outcome. The devout technician might define this process as the fact that history repeats itself while others would suffice to say that we should learn from the past.

The roulette wheel

In my experience, only a minority of technicians can consistently and accurately determine future prices. However, even if you are unable to accurately forecast prices, technical analysis can be used to consistently reduce your risks and improve your profits.

The best analogy I can find on how technical analysis can improve your investing is a roulette wheel. I use this analogy with reservation, as gamblers have very little control when compared to investors (although considering the actions of many investors, gambling may be a very appropriate analogy).

"There are two times in a man's life when he should not speculate: when he can't afford it, and when he can."
- Mark Twain, 1897

A casino makes money on a roulette wheel, not by knowing what number will come up next, but by slightly improving their odds with the addition of a "0" and "00."

Similarly, when an investor purchases a security, he doesn't know that its price will rise. But if he buys a stock when it is in a rising trend, after a minor sell off, and when interest rates are falling, he will have improved his odds of making a profit. That's not gambling--it's intelligence. Yet many investors buy securities without attempting to control the odds.

Contrary to popular belief, you do not need to know what a security's price will be in the future to make money. Your goal should simply be to improve the odds of making profitable trades. Even if your analysis is as simple as determining the long-, intermediate-, and short-term trends of the security, you will have gained an edge that you would not have without technical analysis.

Consider the chart of Merck in Figure 1 where the trend is obviously down and there is no sign of a reversal. While the company may have great earnings prospects and fundamentals, it just doesn't make sense to buy the security until there is some technical evidence in the price that this trend is changing.

Figure 1

Merck Chart

Automated trading

If we accept the fact that human emotions and expectations play a role in security pricing, we should also admit that our emotions play a role in our decision making. Many investors try to remove their emotions from their investing by using computers to make decisions for them. The concept of a "HAL," the intelligent computer in the movie 2001, is appealing.

Mechanical trading systems can help us remove our emotions from our decisions. Computer testing is also useful to determine what has happened historically under various conditions and to help us optimize our trading techniques. Yet since we are analyzing a less than logical subject (human emotions and expectations), we must be careful that our mechanical systems don't mislead us into thinking that we are analyzing a logical entity.

That is not to say that computers aren't wonderful technical analysis tools--they are indispensable. In my totally biased opinion, technical analysis software has done more to level the playing field for the average investor than any other non-regulatory event. But as a provider of technical analysis tools, I caution you not to let the software lull you into believing markets are as logical and predictable as the computer you use to analyze them. Technical Analysis from A to Z

 

 

U.S. Government Required Disclaimer - Commodity Futures Trading Commission. Trading financial instruments of any kind including options, futures and securities have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the options, futures and stock markets. Don't trade with money you can't afford to lose. This training website is neither a solicitation nor an offer to Buy/Sell options, futures or securities. No representation is being made that any information you receive will or is likely to achieve profits or losses similar to those discussed on this website. The past performance of any trading system or methodology is not necessarily indicative of future results. Please use common sense. This site and all contents are for educational and research purposes only. Please get the advice of a competent financial advisor before investing your money in any financial instrument.

NFA and CTFC Required Disclaimers: Trading in the Foreign Exchange market is a challenging opportunity where above average returns are available for educated and experienced investors who are willing to take above average risk. However, before deciding to participate in Foreign Exchange (FX) trading, you should carefully consider your investment objectives, level of experience and risk appetite. Do not invest money you cannot afford to lose.

CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAN ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

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