Thread: Basics of Technical Analysis"New to Trading and Technical Analysis? Learn the Basics

FUNDAMENTAL ANALYSIS seeks to determine future stock price

by understanding and measuring the objective "value" of an equity. The study of stock charts, known as TECHNICAL ANALYSIS, believes that the past action of the market itself will determine the future course of prices.

A stock chart is a simple two-axis (x-y) plotted graph of price and time.

Each individual equity, market and index listed on a public exchange has a chart that illustrates this movement of price over time. Individual data plots for charts can be made using the CLOSING price for each day. The plots are connected together in a single line, creating the graph. Also, a combination of the OPENING, CLOSING, HIGH and/or LOW prices for that market session can be used for the data plots. This second type of data is called a PRICE BAR. Individual price bars are then overlaid onto the graph, creating a dense visual display of stock movement.

Stock charts can be created in many different time frames.


Mutual fund holders use monthly charts in which each individual data plot consists of a single month of activity. Day traders use 1 minute and 5 minute stock charts to make quick buy and sell decisions. The most common type of stock chart is the daily plot, showing a single complete market session for each unit.

Stock charts can be drawn in two different ways.

An ARITHMETIC chart has equal vertical distances between each unit of price. A LOGARITHMIC chart is a percentage growth chart. It has equal vertical distances between the same percentages of price growth. For example, a price movement from 10 to 20 is a 100% move. A move from 20 to 40 is also a 100% move. For this reason, the vertical distance from 10 to 20 and the vertical distance from 20 to 40 will be identical on a logarithmic char

Stock chart analysis can be applied equally to individual stocks and major indices

Analysts use their technical research on index charts to decide whether the current market is a BULL MARKET or a BEAR MARKET. On individual charts, investors and traders can learn the same thing about their favorite companies.

Use the stock chart to identify the current trend.

A trend reflects the average rate of change in a stock's price over time. Trends exist in all time frames and all markets. Day traders can establish the trend of their stocks to within minutes. Long term investors watch trends that persist for many years.

Stocks trade daily with an average volume that determines their LIQUIDITY.

Liquid stocks are very easy for traders to buy and sell. Illiquid stocks require very high SPREADS (transaction costs) to buy or sell and often cannot be eliminated quickly from a portfolio. Stock chart analysis does not work well on illiquid stocks


Breakouts accompanied by volume much higher than the average for that stock


are healthy for the continuation of the price movement in that direction. But after long rallies or declines, stocks often have a day of very high volume known as a CLIMAX. During these days, the last of the buyers or sellers take positions. The stock then reverses as there are no longer enough participants to cause price to move in that direction.


How can you organize the endless stream of stock chart data into a logical format

that doesn't require rocket science to interpret? Charts allow investors and traders to look at past and present price action in order to make reasonable predictions and wise choices. It is a highly visual medium. This one fact separates it from the colder world of value-based analysis

The stock chart activates both left-brain and right-brain functions of logic and creativity.

So it's no surprise that over the last century two forms of analysis have developed that focus along these lines of critical examination.

The oldest form of interpreting charts is PATTERN ANALYSIS.

. This method gained popularity through both the writings of Charles Dow and Technical Analysis of Stock Trends, a classic book written on the subject just after World War II. The newer form of interpretation is INDICATOR ANALYSIS, a math-oriented examination in which the basic elements of price and volume are run through a series of calculations in order to predict where price will go next.

Pattern analysis gains its power from the tendency of charts to repeat the same bar formations over and over again.

These patterns have been categorized over the years as having a bullish or bearish bias. Some well-known ones include HEAD and SHOULDERS, TRIANGLES, RECTANGLES, DOUBLE TOPS, DOUBLE BOTTOMS and FLAGS. Also, chart landscape features such as GAPS and TRENDLINES are said to have great significance on the future course of price action.