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How Does Technical Analysis Relate to Investing?

Technical analysis is the study of how securities prices behave and how to exploit that information to make money while avoiding losses. Basically, with technical analysis, you work to identify price trends (a trend is a discernible directional bias in the price — upwards, downwards, or sideways).

Here are the basic observations underlying technical analysis:

  • Securities prices move in trends much of the time, and trends remain in place until some major event comes along to stop them.

  • Prices incorporate (or discount) all known information about the security, and prices change as new information becomes available. All known information consists of hundreds of factors ranging from accurate facts to opinions, guesses, and emotions — and previous prices. They all go into the supply and demand for a security and result in its price.

  • Primary trends (lasting months or years) are punctuated by secondary movements (lasting weeks or months) in the opposite direction of the primary trend. Secondary trends, or retracements, are the very devil to deal with as a trader.

Your goal is to forecast the price of the security over some future time horizon in order to buy and sell the security to make a cash profit. The emphasis in technical analysis is to make profits from trading, not from owning a security as some kind of savings vehicle, although long-term investors use technical analysis as well.

Because in technical analysis prices and trends rule, you have to be able to track and identify them. Although technical analysts have developed numerous indicators based on price and volume that can be expressed as statistics, tables of numbers, and other formats, you’ll spend most of your time looking at charts, like the one shown below, which illustrates a classic uptrend following a downtrend.

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At the most basic level, your goal is to shun the security shown on the chart while it’s downtrending and to identify the key reversal point — which is the best place to buy — as early as possible. To do this successfully, you absolutely, positively must become attuned to looking at charts and trying to figure out what the prices are telling you.

A chart is the workspace of technical analysis. Technical analysts have developed numerous indicators based on price and volume that can be expressed as statistics, tables of numbers, and other formats, but the core method remains a graphic display of prices on a chart.

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