Technical Analysis
Prices are the lifeblood of technical analysis, and charts provide a visual history -- either for individual stocks or
market averages.----------------------------------------------------------------------------
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Technical Analysis is a discipline relying mainly on patterns of price behavior to predict future prices. You learn to see what the market is doing by interpreting price charts. For example, using Elliott Wave Theory to predict gold stocks. In its strictest form it presumes that any relevant information about a stock or index is reflected in its price. It assumes that in-force patterns in the time-series price behavior can be used to predict behavior. And it stands and falls on its ability -- or the ability of the analyst -- to detect, identify, and interpret patterns (which depend on the type of chart used, the analyst, and what he or she brings to the table).
Expressed in a slightly different way by Martin J Pring:
[It reflects the idea that] the stock market moves in trends, which are determined by the changing attitudes of investors to a variety of economic, monetary, political, and psychological forces. The art of technical analysis ... is to identify changes in such trends at an early stage and to maintain an investment posture until a reversal of that trend is indicated.
Like Robert R Prechter, Pring feels that the market reflects mass psychology, and price movement "reflects the hopes, fears, knowledge, optimism, and greed of the public." Even though human interactions are "so complex that events don't repeat themselves exactly," people continue to make the same mistakes. Their actions show up in similar chart patterns. See Elliott Wave Theory.
Comparing technical analysis with fundamental analysis, Prechter says:
Fundamental analysts use data generated outside the market to come to their conclusions. [They] assess events and situations apart from market behavior, considering them the cause of market movements. They forecast where markets are likely to go in response to those background events or conditions that they feel are significant.
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The price history of securities -- also known as the time-series of prices, from which comes time series analysis -- is represented in various ways, but the more familiar format is that of a bar chart, particularly the linear bar chart.
Price vs. Time Bar Charts
The bar chart is a two-dimensional graph that records prices on the vertical axis and time in the horizontal axis. The linear bar chart uses linear values in its dimensions. Each bar represents a range of prices that occurs in a fixed interval of time for the (fictitious) stock of Brown and Morrison. In a daily price chart, for example, each bar gives the daily range of prices. The time dimension itself could cover either just a few days or many days.
The (linear) bar chart is linear in both vertical and horizontal dimensions in the sense that prices and time each are given in equal increments. Doubling the values would double the size of the representation. However, any scale might be used to represent either the prices or the passage of time. (This would be like using larger or smaller font size.) Similarly, the vertical bars may represent any fraction of the overall time. We might therefore have hourly, daily, weekly, monthly, or other time charts covering days, weeks, months, years, or decades.
You can also find partially nonlinear charts -- called semi-log, or ratio charts -- that use logarithms for the prices. (Semi-log charts are "semi" because they are logarithmic only in the price dimension; in the time dimension they are linear.).
Volume
A second common feature of bar charts is volume, and is usually shown at the bottom of a chart as a succession of vertical bars, one for each of the price bars. Each volume bar represents the number of shares of a stock traded in the time represented by a price bar. In the Brown and Morrison chart, for instance, there would be one volume line under each of the price lines in the chart. So if the chart were a daily chart, each volume bar would give the number of shares of that stock traded on the given day.
Moving Average
A third common feature of bar charts is a graph of the moving average of the prices. There are many ways to express it, depending on (1) the time interval taken for the averages and (2) the weighting of each price value in the averaging interval. But the principle is straightforward. -- a succession of averages of prices obtained over a specified period of time. Click here for more.
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Over the years, analysts have picked up on quite a large variety of chart patterns. The most common and more traditional patterns are the variations of head and shoulder formations and the many triangle patterns. Others include the so-called M shapes, W formations, and rising or falling wedges. See Chart Patterns.
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