Charting or technical analysis
is the use of numerical series generated by market activity, such
as price and volume, to predict future trends in that market. The
techniques can be applied to any market with a comprehensive price
history. Technical analysis does not try to analyze the financial
data of a company such as cashflow, dividends and projection of
future dividends. That type of analysis is called fundamental analysis.
While technical analysis is widely used (if only as one input
among many) by both professional and amateur traders as a means
of predicting future market moves, it is generally not used by economists
in any academic sense.
Technical analysis implicitly rejects the efficiency of the market
as understood in the efficient market hypothesis (EMH). (That is,
using technical analysis on a particular market implicitly assumes
that that market is not efficient, as defined by EMH.) The efficient
markets theories basically argue that existing prices reflect all
available information, and that future price movements will follow
a path that will approximate to a random walk (Brownian motion)
as they adjust to new information as it emerges. The theories further
assume that all participants in the stock market have equal and
instantaneous access to all information that might affect stocks.
Technical analysts or chartists believe that by analysing stock
price histories they can discern sufficient information about the
thinking of buyers and sellers to anticipate future events. That
is, they assume that there is useful information to be gleaned,
i.e. hidden within, price histories; that it is a way of analyzing
the past actions of people in a particular market as reflected by
their actual transactions. As the assumption of an efficient market
is central to almost all option pricing theory, financial mathematicians
working in the area of derivatives generally reject technical analysis
as unscientific. All large banks, however, employ both technical
analysts and financial mathematicians.
The traditional chartists developed familiarity with chart patterns
that seemed to recur repeatedly and gave some of them names e.g.
"head and shoulders" or "flag" or "triangle". They believed that
they could infer probabilities of price action from studying the
patterns. More recent technical analysts use a wide variety of techniques
but, at their best, their methods approximate more closely to a
statistical analysis of price action. For example J.M.Hurst (see
below) used sophisticated techniques (fourier analysis) to search
for meaningful signals amongst the apparent random noise of stock
price movements. The most sophisticated technical analysis software
allows the user to design indicators and to optimise them by testing
their profitability (assuming trading rules and transactions costs)
using historic data; trading stratagems can be designed that utilise
one or more such indicators.
Some of the techniques used and patterns found include:
- Support level - a level below which the price will not likely
- Resistence level - a level above which the price will not likely
- Breakout - when a stock rises above its resistence level or
below it's support level.
- Trend line - a regression line that predicts future prices
based on past prices.
- Trend line penetration - when a price crosses Bollinger bands
or some other measure of the range of standard deviation of the
- Moving Averages - the average price of a stock calculated and
recalculated for a specific number of days. Several types : simple
moving average; weighted moving average; exponential moving average.
- Momentum - ratio of a short term moving average to a long term
- Commodity Channel Indicator -
- Relative strength - ratio of the % price change of a stock
to the % price change of a broader index
- Bollinger bands - a range of price volitility based on the
standand deviation on a moving average or trend line
- Moving average (volume) - the moving average of the daily volume
(rather than price) of trades.
- Gann lines and Gann angles -
- Triangle -
- Ascending bottom -
- Broadening foundation -
- Head and shoulders -
- Inverse head and shoulders -
- Triple top -
- Arms Index (TRIN) -
- Money flow -
- Point and figure charts -
- Technical Analysis of Futures Markets, John J.
Murphy, New York Institute of Finance, 1986
- The Profit Magic of Stock Transaction Timing,
J.M. Hurst, Prentice-Hall, 1970.