What is Technical Analysis?
Technical Analysis is the forecasting of future financial price movements based on an examination of past price movements. Like weather forecasting, technical analysis does not result in absolute predictions about the future. Instead, technical analysis can help investors anticipate what is “likely” to happen to prices over time. Technical analysis uses a wide variety of charts that show price over time.



Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand. Price data (or as John Murphy calls it, “market action&rdquo refers to any combination of the open, high, low, close, volume, or open interest for a given security over a specific time frame. The time frame can be based on intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data and last a few hours or many years.

The Basis of Technical Analysis
At the turn of the century, the Dow Theory laid the foundations for what was later to become modern technical analysis. Dow Theory was not presented as one complete amalgamation, but rather pieced together from the writings of Charles Dow over several years. Of the many theorems put forth by Dow, three stand out:
  • Price Discounts Everything
  • Price Movements Are Not Totally Random
  • “What” Is More Important than “Why”
Chart AnalysisTechnical
analysis can be as complex or as simple as you want it. The example below represents a simplified version. Since we are interested in buying stocks, the focus will be on spotting bullish situations.
Overall Trend: The first step is to identify the overall trend. This can be accomplished with trend lines, moving averages or peak/trough analysis. For example, the trend is up as long as price remains above its upward sloping trend line or a certain moving average. Similarly, the trend is up as long as higher troughs form on each pullback and higher highs form on each advance.
Support: Areas of congestion and previous lows below the current price mark the support levels. A break below support would be considered bearish and detrimental to the overall trend.
Resistance: Areas of congestion and previous highs above the current price mark the resistance levels. A break above resistance would be considered bullish and positive for the overall trend.
Momentum: Momentum is usually measured with an oscillator such as MACD. If MACD is above its 9-day EMA (exponential moving average) or positive, then momentum will be considered bullish, or at least improving.
Buying/Selling Pressure: For stocks and indices with volume figures available, an indicator that uses volume is used to measure buying or selling pressure. When Chaikin Money Flow is above zero, buying pressure is dominant. Selling pressure is dominant when it is below zero.
Relative Strength: The price relative is a line formed by dividing the security by a benchmark. For stocks, it is usually the price of the stock divided by the S&P 500. The plot of this line over a period of time will tell us if the stock is outperforming (rising) or underperforming (falling) the major index.
The final step is to synthesize the above analysis to ascertain the following:
  • Strength of the current trend.
  • Maturity or stage of the current trend.
  • Reward-to-risk ratio of a new position.
  • Potential entry levels for a new long position.
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