Technical Analysis of Stocks and Trends

What is 'Technical Analysis of Stocks and Trends'

Technical analysis of stocks and trends is the study of historical market data, including price and volume. Using both behavioral economics and quantitative analysis, technical analysts aim to use past performance to predict future market behavior. The two most common forms of technical analysis are chart patterns and technical (statistical) indicators.

BREAKING DOWN 'Technical Analysis of Stocks and Trends'

The technical analysis of stocks and trends has been used for hundreds of years. In Europe, Joseph de la Vega adopted early technical analysis techniques to predict Dutch markets in the 17th century. In Asia, Homma Munehisa inspired the creation of candlestick charts that have become increasingly popular in the West as a way to identify chart patterns. These theories were brought together and formalized in 1984 with the publishing of Technical Analysis of Stock Trends by Robert D. Edwards and John Magee.

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The core principle underlying technical analysis is that the market price reflects all available information that could impact a market. As a result, there's no need to look at economic, fundamental, or new developments since they're already priced into a given security. Technical analysts believe that prices move in trends and history tends to repeat itself when it comes to the market's overall psychology.

Types of Technical Analysis

The two major types of technical analysis are chart patterns and technical (statistical) indicators.

Chart patterns are a subjective form of technical analysis whereby technicians attempt to identify areas of support and resistance on a chart by looking at specific patterns. These patterns, underpinned by psychological factors, are designed to predict where prices are headed, following a breakout or breakdown from a specific price point and time. For example, an ascending triangle chart pattern is a bullish chart pattern that shows a key area of resistance. A breakout from this resistance could lead to a significant, high-volume move higher.

Technical indicators are a statistical form of technical analysis whereby technicians apply various mathematical formulas to prices and volumes. The most common technical indicators are moving averages, which smooth price data to help make it easier to spot trends. More complex technical indicators include the moving average convergence-divergence, or MACD, which looks at the interplay between several moving averages. Many trading systems are based on technical indicators since they can be quantitatively calculated.