A day trader who can recognize a trend on the charts can determine where prices are most likely to go until some unforeseen event comes along that creates a new trend. Technical analysis is the tool that helps a day trader to spot those trends.
Technical analysis is based on the premise that securities prices move in trends and that those trends repeat themselves over time. Information about the price, time, and volume of a security’s trading can be plotted on a chart.
The plots form patterns that can be analyzed to show what happened. How did the supply and demand for a security change, and why? And what does that mean for future supply and demand?
The basic element of technical analysis is a bar, which shows you the high, low, open, and closing price of a security for a given day.
In most markets, every day generates a new bar (many traders talk about bars instead of days, and they aren’t talking about where they go after work). A collection of bars, with all their different high, low, open, and close points, is put together into a larger chart. Often, a plot of the volume for each bar runs underneath.
Many patterns formed in the charts are associated with future price moves. Technical analysts thus spend a lot of time looking at the charts to see whether they can predict what is going to happen. Many software packages send traders signals when certain technical patterns occur so that the traders can place orders accordingly.
Technical analysis is a way to measure the supply and demand in the market. It’s a tool for analyzing the markets, not predicting them. If deciphering the meaning of the data were that easy, everyone would be able to make money in the markets.
Price changes
Market observers debate market efficiency all the time. In an efficient market, all information about a security is already included in the security’s price, so there’s no point to doing any research at all.
Few market participants are willing to go that far, but they concede the point that the price is the single most important summary of information about a company. That means that technical analysis, looking at how the price changes over time, is a way of learning about whether a security’s prospects are improving or getting worse.
Volume changes
The basic bar shows how price changed during the day, but adding volume information tells the other part of the story: how much of a security was demanded at that price. If demand is going up, then more people want the security, so they are willing to pay more for it. The price tells traders what the market knows; the volume tells them how many people in the market know it.