What is technical analysis?
Technical analysis is the forecasting of markets through the study and analysis of data generated exclusively from the buying and selling of financial instruments. It is part science and part formalization of trader intuition and experience. Any market for which there is a regular, transparent transaction history is a candidate for technical analysis. Planetary cycles, opinion polls, fundamental, monetary and economic data as well as any data not specifically generated from the buying and selling process are not, nor have ever been, a part of true technical analysis.
Prices—to include interest rates, exchange rates, and stock and commodity prices—are usually detached from fundamental values by swings in expectations and sentiment, investor overreaction and underreaction to news, and the market impact of price and performance-driven strategies. For example, commodity trading advisors (CTAs) rely primarily on technical models and have grown to become a dominant influence in the commodity markets. Similarly, equity portfolio managers often rotate between groups and sectors for no other reason than the fear of underperforming a benchmark. These actions, sometimes referred to as herding behavior, can significantly effect price dynamics. Put another way, liquidity overwhelms fundamental factors far more often than efficient market theory would have us believe. Technical analysis attempts to address these facts by dealing directly with the forces of supply and demand for the instruments of a market.
While the idea that fundamental trends follow market trends is central to technical analysis philosophy, the use of technical analysis in no way precludes the use of other approaches. Technical analysis is regarded by many, inluding us, as complimentary to fundamental analysis.
History of technical analysis
While its precise origins are unknown, technical analysis is perhaps the oldest form of financial and commodity market analysis known to man. Many believe technical analysis traces its roots to Japan in the mid 1700’s, where it was used to forecast rice prices on the world’s first organized commodity futures exchange. In the U.S., technical analysis evolved from methods practiced by “tape readers” in the late 1800s, and from observations made by Charles Dow, The Wall Street Journal’s first editor. After his death in 1902, Dow’s writings on finance and investment were codified into a set of theories that form the basis of modern technical analysis. These theories include the nature and composition of price trends, trend confirmation and divergence, the idea that prices represent the aggregate knowledge of the market and the importance of volume.