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What is Technical Analysis?

Definition: Technical analysis of stock trends focuses on the observation of price charts and specific indicators, aiming to identify consistent trend patterns in the movement of stocks as well as consistent relationships between price sequences that seem to interact in a prescribed manner.

What Does Technical Analysis Mean?

What is the definition of technical analysis? Technical analysis focuses exclusively on the study of price charts and trading history to determine the future price movements. Without taking into consideration any information related to the firmís fundamentals, technical analysis seeks to determine a likely direction in the future price movements assuming that:

  1. supply and demand determine the price of any security
  2. price movements are influenced by personal perceptions
  3. prices of securities move in trends

Technical analysts use a variety of leading and lagging indicators, which precede or follow a price movement, respectively, to estimate the future movement of the stock prices as well as moving averages, Moving Average Convergence Divergence (MACD) indicators, trading volume history, and more.

Letís look at an example.

Example

Adam is a technical analyst, and he is interested in buying some stocks for his clients. Adam observes some technical charts to identify potential bullish positions.

The first step is to identify the overall trend of the market by using trendlines or moving averages. For prices that remain above the upward trend line, there are bullish opportunities.

Then, Adam identifies the support and resistance points, which are practically the levels that determine the supply (resistance) and demand (support) for securities. At support levels, the demand is higher than supply, thus preventing the stock price to decline further. At resistance levels, supply is higher than demand, thus preventing the stock price to rise further. Therefore, as the price declines towards the support level, more buyers will enter the market to buy the security. Once the price reaches the support lever, the demand will outweigh supply, thus preventing a further decline in the stock price. Likewise, as the price rises towards the resistance level, more sellers will enter the market to buy the security. Once the price reaches the resistance level, the supply will outweigh demand, thus preventing a further rise in the stock price.

In fact, Adam has identified a momentum in the movement of prices, but he wants to confirm it with the use of the MACD indicator.

Finally, Adam concludes that the stocks that have a Chaikin Money Flow (CMF) indicator > 0, there are bullying opportunities as the average money flow for a determined period is positive.

Summary Definition

Define Technical Analysis: Technical analysis means a method of tracking stock prices to evaluate and compare potential investments.

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