Understanding Technical Analysis

Technical analysis is concerned with what has actually happened in the market, rather than what should happen. A technical analyst will study the price and volume movements and from that data create charts (derived from the actions of the market players) to use as his primary tool. The technical analyst is not much concerned with any of the "bigger picture" factors affecting the market, as is the fundamental analyst, but concentrates on the activity of that instrument's market.

Technical analysis is based on three underlying principles:

1. Market Action Discounts Everything - This means that the actual price is a reflection of everything that is known to the market that could affect it, for example, supply and demand, political factors and market sentiment. The pure technical analyst is only concerned with price movements, not with the reasons for any changes.

2. Prices Move In Trends - Technical analysis is used to identify patterns of market behavior which have long been recognized as significant. For many given patterns there is a high probability that they will produce the expected results. Also there are recognized patterns which repeat themselves on a consistent basis.

3. History Repeats Itself - Chart patterns have been recognized and categorized for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little with time.

Price Charts Chart types video clip

Chart patterns

There are a variety of charts that show price action. The most common are bar charts. Each bar will represent one period of time and that period can be anything from one minute to one month to several years. These charts will show distinct price patterns that develop over time. (As shown below)

Candlestick patterns

Like bar charts patterns, candlestick patterns can be used to forecast the market. Because of their colored bodies, candlesticks provide greater visual detail in their chart patterns than bar charts. (As shown below)

Point & figure patterns

Point and figure patterns are essentially the same patterns found in bar charts but Xs and Os are used to market changes in price direction. In addition, point and figure charts make no use of time scales to indicate the particular day associated with certain price action. (As shown below)

Categories of the technical analysis theory: