Technical Analysis

Technical Analysis is used to determine optimal entry and exit points. A Technical Analyst looks at the relationship between a stock's price, its volume, and other additional indicators to pinpoint a potential time to buy or sell.

History of Technical Analysis

The Japanese were the first to use technical analysis in the form of candlestick charting to trade some of the world's first rice futures during the 1600s. Today, approximately 400 years later, candlestick charting plays and increasingly important roll in technical chart analysis (we will cover Japanese “Candlesticking” in detail in a later chapter entitled “Candlestick Charting”).

The beginning of modern-day technical analysis started around 1900, when Charles Dow developed the Dow Theory. Dow wanted a method to find out, either directly or indirectly, the trending nature of prices: how divergence and volume drive price changes and create support/resistance lines. Today, the public watches the Dow Jones Industrial Average (DJIA) as an indicator of the sentiment in the market. The reason we use Technical Analysis is simple. When it is properly understood and used, it will help you identify buy or sell signals. In the absence of technical analysis, determining when to buy or sell a stock would simply be a matter of guesswork.

Chart for Technical Analysis

A price chart is a chain of prices plotted over a specific time frame that allows us a look at how greed and fear affect a stock's price. On the chart, the y-axis (vertical axis) represents the price scale in dollars, and the x-axis (horizontal axis) represents the time scale in minutes, hours, days, etc. Prices are plotted from left to right across the x-axis, with the most recent plot being the furthest on the right.

Charts can be formed using any type of tradable financial instrument, which includes – but is not limited to – stocks, bonds, commodities, futures, and market indices. Any security with price data over a period of time can be used to form a chart for analysis.

Although technical analysts use charts almost exclusively, using charts is not limited to just technicians. They can also be of great benefit to fundamental analysts because they provide an easy-to-read graphical representation of a security's price movement, making it easy to spot the effect of key price events and performance over a period of time.