Technical Analysis

1. What is Technical Analysis?

Technical analysis (TA) is a methodology for evaluating financial assets by studying historical price movements and trading volume. Rather than analysing a company's financial statements or economic conditions (which is called fundamental analysis), technical analysts focus exclusively on the data produced by market activity itself — primarily price and volume.

The underlying premise of technical analysis is that all known information about an asset is already reflected in its price, and that patterns in price history tend to repeat due to consistent human behavioural responses to market conditions.

It is important to state clearly from the outset: technical analysis is a tool for studying past market behaviour, not for predicting future prices with certainty. Professional traders who use TA do so as one input among many, and most acknowledge its significant limitations.

2. Price Charts Explained

A price chart is a graphical representation of an asset's price over time. The horizontal axis (x-axis) represents time, and the vertical axis (y-axis) represents price. Charts can display data across different timeframes — from one-minute charts used by very short-term traders to monthly charts used for long-term analysis.

The three main chart types are:

• Line chart: The simplest form — plots the closing price for each period and connects them with a line. Gives a clear overall view of price direction but loses detail about intra-period price movement.
• Bar chart (OHLC): Each bar shows the Open, High, Low, and Close price for the period. Provides significantly more information than a line chart.
• Candlestick chart: The most widely used in modern trading education. Similar information to bar charts but displayed in a visually intuitive format. Covered in detail in the next section.

3. Candlestick Charts

Candlestick charts originated in 18th-century Japan and were used to track rice prices. They were introduced to Western audiences by technical analyst Steve Nison in the 1990s and are now the dominant chart format used globally.

Each candlestick represents one period (one minute, one hour, one day, etc.) and displays four key data points:

• Open: The price at the start of the period
• Close: The price at the end of the period
• High: The highest price reached during the period
• Low: The lowest price reached during the period

4. Trends and Trend Lines

One of the core concepts in technical analysis is the trend. Markets tend to move in sustained directional patterns — uptrends, downtrends, or sideways (ranging) markets. Identifying the prevailing trend is often considered the first step in technical analysis.

• Uptrend: Characterised by a series of higher highs and higher lows. Prices are generally moving upward over the period.
• Downtrend: Characterised by lower highs and lower lows. Prices are generally moving downward.
• Sideways / Ranging: Price moves within a relatively defined horizontal range without a clear directional bias.

Trend lines are straight lines drawn on a chart connecting a series of highs or lows to visually represent the direction and angle of a trend. An upward-sloping line connecting rising lows is an uptrend line; a downward-sloping line connecting falling highs is a downtrend line.

5. Support and Resistance

Support is a price level at which an asset has historically had difficulty falling below — often because buying interest tends to increase around that level. Resistance is the opposite: a price level at which upward movement tends to slow or reverse due to increased selling pressure.

These concepts form the basis of many technical trading strategies. When a price breaks through a resistance level, that level may become support. When it breaks below support, that level may become resistance. This phenomenon is known as a role reversal.

6. Common Chart Patterns

Technical analysts identify recurring formations in price charts that they believe signal potential future price direction. These patterns fall into two categories: continuation patterns (suggesting the existing trend will continue) and reversal patterns (suggesting the trend may change direction).

Some commonly studied patterns include:

• Head and Shoulders: A reversal pattern consisting of three peaks — a higher middle peak (the "head") flanked by two lower peaks ("shoulders"). Often interpreted as a signal that an uptrend may be weakening.
• Double Top / Double Bottom: Reversal patterns where price reaches a similar high or low twice, suggesting the market has been unable to break through that level.
• Triangles (Ascending, Descending, Symmetrical): Continuation patterns formed by converging trend lines, often preceding a breakout in one direction.
• Flags and Pennants: Short-term consolidation patterns following a strong directional move, often continuing in the same direction.

7. Technical Indicators

Technical indicators are mathematical calculations based on price and/or volume data that are plotted on or alongside a chart. They are designed to help analysts identify trends, momentum, volatility, and potential turning points.

8. Volume Analysis

Volume refers to the total number of shares, contracts, or units of an asset that are traded during a given period. Volume is often plotted as a histogram at the bottom of a price chart.

Volume analysis is used by technical analysts to assess the strength or conviction behind price movements:

• A price increase accompanied by high volume is generally seen as a stronger signal than the same move on low volume.
• A price decline on declining volume may suggest the selling pressure is weakening.
• Volume spikes often coincide with major news events and can precede significant price movements in either direction.

9. Limitations of Technical Analysis

Technical analysis is widely studied and used, but it is also widely criticised. It is essential for any learner to understand its significant limitations:

• No predictive certainty: Technical analysis identifies patterns in historical data. There is no guarantee that historical patterns will repeat in the future, or repeat in the same way.
• Subjectivity: Identifying patterns, drawing trend lines, and interpreting indicators involves significant subjective judgment. Two skilled analysts can look at the same chart and reach different conclusions.
• Self-fulfilling and self-defeating: When very large numbers of traders act on the same signals, those signals can become self-fulfilling — but also self-defeating when markets anticipate and move against them.
• Ignores fundamentals: TA does not account for a company's financial health, macroeconomic conditions, or the fundamental value of an asset.
• Academic scepticism: The Efficient Market Hypothesis (EMH), widely studied in academic finance, posits that current prices already reflect all available information — suggesting that past price patterns cannot reliably predict future prices.

10. Summary & Key Terminology