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Patrick Stockdale
Written by Patrick Stockdale | June 22, 2022

What Is Technical Analysis?

Technical analysis is a trading discipline and method of measuring, studying and forecasting the price movements of any financial market by examining past market data including historical price, open interest and volume data.

The core assumption of technical analysis is that the current price of a market reflects all known factors including fundamentals like the news and economic factors; thus, there is no need to examine these fundamental factors when examining a market.

However, in practice, many professional analysts and technical traders still prefer to use both forms of analysis to find trading ideas.

Technical analysis relies on technical indicators, chart patterns, candlestick patterns and historical price trends of a tradable instrument to help predict future price movements.

The core principles of a technical analysis approach to trading and investing is that the price history of a tradable instrument tends to repeat itself, market action discounts everything and price moves in trends (1).

Typically, technical analysis will work best in more liquid markets where technical traders can easily enter and exit a market without slippage.

A person whose job is to use a technical analysis methodology for price forecasting is known as a "technical analyst", "market technician", "chartist" or "professional analyst".

Using Technical Analysis

Applying technical analysis allows traders and investors to do either a top-down approach or a bottom-up approach to analyzing markets.

Technical analysts, technical traders and investors choose from four different methods when using technical analysis of a tradable asset.

The four methods used to apply technical analysis are:

  1. Technical Indicators: Technical indicators are indicators placed either on an overlay of a price chart of a tradable instrument or just below the price chart itself. Technical traders and investors will use these trading indicators to help predict future price moves, understand the potential direction of the price and identify the current market trend
  2. Chart Patterns: Chart patterns are price patterns that form as graphical representations on a price chart that signal a potential future direction of the price of the market and help understand the behavior of investors and traders.
  3. Candlestick Patterns: Candlestick patterns are candlestick formations or price patterns that form on Japanese candlestick charts. A candlestick pattern helps understand the trading activity, investor behavior and find trading opportunities
  4. Support/Resistance Price Levels: Support and resistance levels are price levels drawn onto the charts of market prices to help identify a price range in a market and make investment decisions. They can also help understand the direction of price and perform analysis of price movements.

Using Technical Indicators To Do Technical Analysis

The first method of using technical analysis is by using technical indicators to help perform the analysis of a market.

Technical indicators will help measure supply and demand within a market and help a trader to identify potential technical trading setups.

From the CMT Association Literature Review Of Technical Analysis, Modern Perspectives:

"Underlying principles of the study of technical analysis are derived
from the assumption that changes in the supply and demand of traded securities affect their current market prices. Tools of technical analysis are built
into a framework that seeks to gain insight from the changes in supply and
demand. This framework has evolved over time from a purely visual analysis to more quantitative techniques." (2)

The data that technical indicators use to "indicate" is derived from the price and/or volume of a market.

Within technical analysis, there are thousands of different technical indicators a technical trader or investor can use as part of trading or investment strategies.

A trader will generally develop a technical trading strategy by applying one or just a few of these technical indicators together to help understand historical price action and identify future price trajectories.

Technical indicators generally fall into two types:

  1. Momentum Indicators: Momentum indicators are trading indicators that measure how much momentum is in a market. They can help a trader or investor perform market strength analysis. Example momentum indicators include moving averages or pivot point indicators.
  2. Mean Reversion Indicators: Mean reversion indicators are trading indicators that measure when an upward trend or downward trend is entering into overbought or oversold territory and the market price may reverse and revert back. Example mean reversion indicators include a bollinger band, relative strength index (R.S.I) etc.

Technical indicators can also assist a trader with performing intermarket analysis by using technical divergences to help.

Essentially, technical divergence is a method of using technical indicators to compare the strength of one market versus another market. An example would be measuring how strong a stock is relative to the broader market.

Active traders like day traders and scalpers will typically use popular day trading indicators to help do technical analysis in a market whereas swing traders and long-term investors will typically use popular swing trading indicators to analyze the market.

Technical Analysis Indicators Examples

Using a technical indicator in technical analysis example

The above chart is an example of a technical indicator (Bollinger Bands) overlaid on the price chart.

Examples of technical indicators used in technical analysis include:

  • Relative Strength Index (R.S.I)
  • Stochastics Indicator
  • Fibonacci Indicator
  • Moving Averages
  • MACD
  • Volume
  • Bollinger Bands
  • Keltner Channels
  • Volume Weighted Average Price (VWAP)
  • Ease Of Movement
  • Average Directional Index
  • Money Flow Index
  • Ichimoku Cloud

Using Chart Patterns To Do Technical Analysis

The second method of using technical analysis is by using chart patterns to help analyze the financial markets.

Chart patterns help a trader to perform an analysis of price movements and make future price predictions if the price can break out or break down from these price patterns.

Within technical analysis, there are nearly one hundred different chart patterns that can form on the price chart of a market.

A trader will use chart patterns to identify potential new bullish and rising movement in a market or potential new bearish and downward movement in a market.

Chart patterns typically fall into two types:

  1. Continuation Patterns: Continuation chart patterns are chart pattern formations that signal a potential continuation of a bullish or bearish price trend. Examples of continuation patterns include flags, pennants, rectangles etc.
  2. Reversal Patterns: Reversal chart patterns are chart pattern formations that signal a potential reversal in the price trend from bullish to bearish or vice versa. Examples of reversal patterns include wedges, head & shoulders and inverse head & shoulders etc.

Chart patterns will also help traders and investors identify bullish and bearish investor behavior and identify

Technical traders will browse various markets to find bullish price chart patterns forming to identify potential buying signals and bearish price chart patterns to identify shorting signals.

Technical Analysis Chart Pattern Examples

Using a chart pattern in technical analysis example

On the price chart above, there is an example of a chart pattern that formed, in this instance, a head and shoulders pattern.

Examples of chart patterns used in technical analysis include:

Using Candlestick Patterns To Do Technical Analysis

The third method of using technical analysis is by using candlestick patterns to help analyze capital markets and securities.

Candlestick patterns are candlestick formations that help a trader and chartist to understand market psychology and identify trading setups. Candlestick patterns can only form on candlestick price charts.

There are two types of candlestick patterns:

  1. Bullish Candlestick Patterns: Bullish candlestick patterns are candlestick pattern formations that indicate that the price of a market may increase and move higher in the future, e.g. the hammer, inverted hammer etc.
  2. Bearish Candlestick Patterns: Bearish candlestick patterns are candlestick pattern formations that indicate that the price of a market may decrease and move lower in the future, e.g. bearish engulfing, evening star etc.

Examples Of Candlestick Patterns

Using a candlestick pattern in technical analysis example

On the price graph above, there is an example of a candlestick pattern (shooting star).

Examples of candlestick patterns used in technical analysis include:

  • Hammer
  • Inverted Hammer
  • Morning Star
  • Bearish Engulfing
  • Bullish Engulfing
  • Evening Star
  • Tweezer Bottom
  • Three Black Crows
  • White Marubozu
  • Three Outside Up
  • Piercing Pattern
  • Doji
  • Spinning Top
  • Hanging Man
  • Shooting Star

Using Support/Resistance Levels To Do Technical Analysis

The fourth method of using technical analysis is by using support and resistance levels to help analyze various markets.

A support level is an area on a price chart where the price does not go lower and instead bounces and moves higher.

A resistance level is an area on a price chart where the price does not go higher and instead reverses and moves lower.

There are three types of resistance levels and three types of support levels.

The three types of resistance levels are:

  1. Horizontal Resistance Level: A horizontal resistance level is a horizontal level where the price of a market can not rise through and go higher. Typically, the resistance level is drawn with a horizontal line connecting the swing high levels of the price together.
  2. Rising Resistance Level: A rising resistance level is an uptrend resistance line where the price of a market can not move through. Typically, a rising resistance level is drawn by connecting higher swing highs in prices together and a rising resistance level is trending upwards.
  3. Declining Resistance Level: A declining resistance level is a down-trending level where the price of a market can not rise through and move higher. Typically, the resistance level is drawn with a downtrend line connecting the lower swing highs of the prices together.

The three types of support levels are:

  1. Horizontal Support Level: A horizontal support level is a horizontal price level where the price of a market can not decline below and go lower. Typically, the horizontal support level is drawn with a horizontal line connecting the swing low price levels together.
  2. Rising Support Level: A rising support level is an uptrend support line where the price of a market can not move below. Typically, a rising support level is drawn with a rising line connecting the higher swing lows of the prices together.
  3. Declining Support Level: A declining support level is a down-trending level where the price of a market can not move below. Typically, the declining support level is drawn with a downtrending line connecting the lower swing lows of the prices together.

Example Of Support & Resistance Levels

Using support and resistance levels in technical analysis example

On the price chart above, there are examples of support and resistance levels.

Assumptions Of Technical Analysis

As published in "Technical Analysis Of The Financial Markets" by John Murphy, there are three basic assumptions of technical analysis.

The three basic assumptions of technical analysis are:

  1. Market Action Discounts Everything
  2. Prices Move In Trends
  3. History Repeats Itself

Market Action Discounts Everything

The first assumption of technical analysis is that market action discounts everything. In technical analysis, market action discounts everything means that anything that can affect the price including political events, economic events, psychological factors, market sentiment etc. is already reflected in the price.

As a result of this assumption, it is believed by a technical trader or technical analyst that the only required method of forecasting prices and studying the market is by using technical analysis as everything is already reflected in the price.

Price Moves In Trends

The second assumption of technical analysis is that the price action in a market tends to move in bullish and bearish trends.

Many of the indicators, chart patterns and candlestick patterns are developed on the premise that a market will break out of a price range and start to trend higher or lower.

History Repeats Itself

The final assumption of technical analysis is that history tends to repeat itself. By studying historical chart patterns and measuring these repetitive patterns outcomes, a technical analyst believes that these patterns will repeat again and can help predict the direction of market price in the future.

Technical Analysis Tools

A trader or investor will need to have certain technical analysis tools available to help them do technical analysis of a financial market.

Technical tools needed to do technical analysis include:

  • Charting Tools: Charting tools are tools that provide traders and investors with a graphical representation of the prices of markets, usually the open, high, low and closing prices. Typically charting tools will offer different types of price charts including bar charts, line charts, candlestick charts and point & figure charts.
  • Indicator Tools: Indicator tools are tools that provide traders with technical indicators. Typically, charting tool providers will also offer indicator tools to place on their price charts as part of their packages.
  • Alert Tools: Alert tools are tools that offer price alerts, chart pattern formation alerts and technical indicator alerts to inform a trader or investor about predefined market activity.
  • Scanning Tools: Scanning tools are tools used to scan for price alerts, chart patterns, technical indicator levels etc. Scanning tools will help save time for a trader or investor.

These technical tools are essential for performing technical analysis. Without them, the analysis can not be done.

What Markets Can Technical Analysis Be Used In?

Technical analysis can be used in any tradable instrument with historical price and volume data.

Today, technical analysis is most commonly used and applied in many popular markets including:

  • Stock Markets: Technical analysis is used by stock traders to perform statistical analysis and forecast price movements of individual stocks in many stock markets around the world including the Nasdaq, FTSE and Nikkei.
  • Forex Markets: Technical analysis is used by forex traders forecast future price movements in all forex markets, examples including EUR/USD, USD/CAD, EUR/GBP, GBP/USD etc.
  • Cryptocurrency Markets: With the increased popularity of crypto trading in recent years, technical analysis is used by cryptocurrency traders to help predict future price movements, most commonly in cryptocurrencies like Bitcoin and Ethereum.
  • Bond Markets: Technical analysis is used by bond traders to help analyze bond markets like treasury bills and other government-issued bonds.
  • Commodity Markets: Technical analysis has been used for decades in the commodity markets to help predict future commodity price movements. Example commodity markets where technical analysis is most common include Silver, Gold, Soybeans and Corn.
  • Futures: Technical analysis is used by futures traders in many trading strategies in the futures markets including S&P 500 futures, Euro futures and Crude Oil futures etc.
  • Options: Technical analysis is used by options traders and investors to identify trading setups

Technical analysis is commonly used to generate short-term and long-term trading signals for both day traders and swing traders in these financial markets.

Technical Analysis Timeframes

Technical analysis can be used on any timeframe to analyze the price charts of markets and there are no restrictions or limitations to what timeframes can be used.

Popular timeframes used to do technical analysis of a financial market include:

  • 1-minute: These are price charts where every bar or trading period represents 1 minute of trading activity on a price chart. Typically, short-term scalpers and high-frequency traders will use this timeframe to trade the market.
  • 5-minute: These are price charts where every bar or trading period represents 5 minutes of trading activity on a price chart. Typically, day traders will use this timeframe to trade the market.
  • 30-minute: These are price charts where every bar or trading period represents 30 minutes of trading activity on a price chart. Typically, intraday traders will use this timeframe to trade the market.
  • Hourly: These are price charts where every bar or trading period represents 1 hour of trading activity on a price chart. Typically, day traders and shorter-term swing traders will use this timeframe to trade.
  • Daily: These are price charts where every bar or trading period represents 1 day of trading activity on a price chart. Typically, swing traders will use this timeframe to trade the market.
  • Weekly: These are price charts where every bar or trading period represents 1 week of trading activity on a price chart. Typically, longer-term traders or investors will use this timeframe to trade the market.

Alternatively, less popular timeframes used to do technical analysis include tick charts, 15- minute charts, 2-hour charts, 3-hour charts and 4-hour charts.

Technical Analysis Industry

There are many associations from around the world that represent the technical analysis industry.

The most widely recognized and popular associations of the technical analysis industry are:

  • International Federation Of Technical Analysts (IFTA): The IFTA is a global organization of market analysis associations. The IFTA offers two certifications to its members, the Certified Financial Technician and the Master Of Financial Technical Analysis. It was introduced in 1986 and has member societies in 21 countries.
  • Chartered Market Technician Association (CMT Association): The CMT Association is an American association of technical analysts. The CMT Association is credentialing and advocacy body that offers three exams for its members: CMT Level 1, CMT Level 2 and CMT Level 3.
  • American Association Of Technical Analysis (AAPTA): The AAPTA is another American association of technical analysts. It was incorporated in 2004. This association offers networking events and conferences for technical analysts to meet other like-minded individuals.
  • Technical Security Analysts Of San Francisco (TSAASF): The TSAASF is another American association of technical analysts. It was formed in 1970 and is the oldest society in the United States devoted to the study and development of technical analysis. The TSAASF offers members access to seminars, lunches, meetings and a newsletter to help them stay up to date on technical analysis skills.
  • Society Of Technical Analysts (STA): The STA is a United Kingdom association of technical analysts. Members get access to meetings by leading practitioners, networking events, videos, a forum, a journal published twice a year and courses to learn technical analysis.
  • Institute Of Technical & Quantitative Analysts (IEATEC): The IEATEC is a Spanish association of technical analysts. Members receive training, tools, meetings, webinars and exams and certifications on technical analysis in Spanish.
  • The Association of Technical Analysts (ATA): The ATA is a technical analysis association based in India. Members of the association have access to meetings, webinars and training on technical analysis. The ATA was incorporated in 1986.

Technical Analysis History

The history of technical analysis involves important pioneers throughout its beginnings including:

  • Joseph de la Vega
  • Homma Munehisa
  • Charles Dow

The origins of technical analysis can be dated back to the 17th century when a very primitive version of technical analysis appeared in an Amsterdam-based merchant named Joseph de la Vega’s book.

The book released in 1688 titled “Confusion de Confusiones” provided an insight into the Dutch financial markets by using a very basic version of technical analysis to provide such insights (3).

Candlestick charts and the technical analysis techniques derived from candlestick charts were developed by Homma Munehisa, a Japanese rice trader (4).

His book, “The Fountain Of Gold-The Three Monkey Record Of Money” was released in 1755 and is the first book on market psychology and the book also mentions chart patterns like uptrends and downtrends (5).

Technical analysis became more popular when Charles Dow, founder of the Wall Street Journal and the Dow Jones Industrial Index published the Dow theory and modern technical analysis concepts in the Wall Street Journal between 1899 to 1902 (6).

Since the introduction of Dow theory, technical analysis has been promoted in many books by author Richard W. Schabacker in the 1920’s and 1930’s (7).

It was further promoted by authors John Magee and Robert D. Edwards in their book “Technical Analysis of Stock Trends” in 1948 and has evolved into many thousand mathematical technical indicators and hundreds of chart patterns since then (8).

Summary
The earliest publications about technical analysis were found in 1688 by Joseph de la Vega. Candlestick charts and technical analysis of candlesticks charts were invented by Japanese rice trader Homma Munehisa.

Technical Analysis Limitations

While there are many myths about technical analysis, certain academics have argued that technical analysis is not a good indicator or predictor of future price movements because they believe that tradable markets are already extremely efficient in reflecting information about tradable assets.

The accepted view from some academics is that when information arises, the news spreads very quickly and is incorporated into the prices of the tradable asset without delay thus rendering technical analysis useless (9).

Further studies produced by CFA Institute Research Foundation concluded that early research papers on the efficient market hypothesis and the efficacy of technical analysis were often too narrow, the datasets were too small and the results could not be repeated (10).

Many top traders have produced stellar performances every year applying a technical analysis approach further providing evidence that technical analysis when applied correctly can assist a trader in producing above-average returns (11).

There are also many great books about technical analysis that provide further evidence of the usefulness of applying technical analysis methods to reading and performing financial analysis of the markets.

Summary
Academics have argued that technical analysis does not work because the market is always extremely efficient. This has been debunked by the CFA Institute Research Foundation.

Difference Between Technical Analysis & Fundamental Analysis

There are two main differences between technical analysis and fundamental analysis. These are:

  1. What It Analyzes: Technical analysis focuses on historical price charts, volume, chart patterns, indicators and candlestick patterns whereas fundamental analysis focuses on economic factors and political factors like earnings reports, intrinsic values, balance sheets, interest rates, geopolitical tensions and inflation etc.
  2. The Job Titles Of Professionals Working In The Two Fields: A person employed and working with technical analysis is called a technical analyst whereas a person employed and working with fundamental analysis is called a fundamental analyst.

Frequently Asked Questions

Below are frequently asked questions about technical analysis.

Does Technical Analysis Work?

Technical analysis has proven to work as evident by a number of successful traders using a technical analysis technical approach to trading financial markets.

Some top traders that have clearly shown that technical analysis when employed correctly can produce great returns include:

  • Mark Minervini
  • William O Neill
  • David Ryan
  • Nicholas Darvas
  • Jesse Livermore

Each of these successful traders used a technical analysis style strategy for trading and investing.

A study published in the Journal Of Finance And Quantitative Analysis, Volume 51, Issue 6 titled "Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry" showed the results of a unique test on the effectiveness of technical analysis in different sentiment environments.

The findings from the study were that hedge funds using technical analysis during high-sentiment periods exhibited higher performance, lower risk, and superior market timing ability than non-users of technical analysis.

However, it also found that the advantages of using technical analysis disappear during low-sentiment periods (12).

Is Technical Analysis A Job?

A person can be hired to perform technical analysis. These professionals are known as technical analysts, chartist, market technicians or professional analysts.

Typically, banks, hedge funds, and financial media companies hire these professionals.

Article Sources

Below is a list of every source used in this article.

  1. "Technical Analysis: Three Premises" by CMT Association https://cmtassociation.org/kb/technical-analysis-three-premises/
  2. "Technical Analysis Modern Perspectives" by the CFA Institute Research Foundation https://www.cfainstitute.org/-/media/documents/book/rf-lit-review/2016/rflrv11n11.ashx
  3. "Confusion de Confusiones" by Jose de la Vega https://books.google.com/books?redir_esc=y&id=16_aDwAAQBAJ&q=
  4. "Japanese Candlestick Charting Techniques: A Contemporary Guide to the Ancient Investment Techniques of the Far East" by Steve Nison https://books.google.com/books?id=nz57QgAACAAJ&dq=isbn:9780139316500&hl=en&sa=X&redir_esc=y
  5. "Honma, The Foundation Of Gold" by Honma Munehisa https://books.apple.com/us/book/honma-the-fountain-of-gold/id1476946582
  6. "Evolution Of The Dow Theory" by George W. Bishop, Jr., Financial Analysts Journal, Volume 17, No.5, September 1961 https://www.jstor.org/stable/4469247
  7. "Technical Analysis And Stock Market Profits" by Richard Wallace Schabacker https://books.google.com/books/about/Technical_Analysis_and_Stock_Market_Prof.html?id=5s8JAQAAMAAJ&redir_esc=y
  8. "Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications" by John Murphy https://books.google.com/books/about/Technical_Analysis_of_the_Financial_Mark.html?id=ojTgDwAAQBAJ&source=kp_book_description&redir_esc=y
  9. "The Efficient Market Hypothesis and Its Critics" by Burton G. Malkiel, Journal of Economic Perspectives, Volume 17, No. 1, 2003 https://pubs.aeaweb.org/doi/pdfplus/10.1257/089533003321164958
  10. "Technical Analysis Modern Perspectives" by the CFA Institute Research Foundation https://www.cfainstitute.org/-/media/documents/book/rf-lit-review/2016/rflrv11n11.ashx
  11. "Financial Competitions, Current Monthly Standings" https://financial-competitions.com/
  12. "Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry" by David M. Smith, Na Wang, Ying Wang and Edward J. Zychowicz, Journal Of Financial And Quantitative Analysis, Volume 51, Issue 6. https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/abs/sentiment-and-the-effectiveness-of-technical-analysis-evidence-from-the-hedge-fund-industry/C8DD9ED6B5B5245D7E9E7A44B1421F2E