TECHNICAL ANALYSIS
Technical analysis began in Japan with a technique called ‘anchor charts’ used in the Kyoto era from 1716. Then in around 1750 a wealthy Japanese businessman called Munehisa Homma (a.k.a Sakata) started trading rice markets at the local exchange with these techniques and legend says that he had 100 straight winners without loss! Sakata also invented the early forms of candle charting and during the Meiji period in 1868 modern candlesticks were born and are still one of the most widely used chart types by analysts today.
Later in the U.S Charles H. Dow began to produce technical analysis in the form of a stock market average, and his founding work, known as Dow Theory, is regarded as the very basis of Technical Analysis. Technical Analysis (TA) is the art and science of using market generated data to correctly forecast movement in prices. Technical analysis uses market activity, past prices, open interest and volume and is not concerned with the intrinsic value of a security.
Technical analysis is the discipline/art of using market generated data to correctly forecast movement in prices.
It uses market activity, past prices, open interest, and volume and is not concerned with the intrinsic value of a security, and therefore it is an attempt to gauge market sentiment.
In the pursuit of using technical charting we must accept basic assumptions that state:
MARKET ACTION DISCOUNTS ALL KNOWN INFORMATION
Given a free market price movement reflect changes in supply and demand, and at any one time the price is the balance between the two. All knowledge and expectations – whether economic, political or psychological – are reflected in the price. The price is therefore the sum of the feelings or opinions of all market participants. As perceptions change, then the price will adjust to reflect this.
A sudden change in fundamentals – the unexpected and presumably the unforeseen – will result in a market shift in perceptions and an abrupt change in price. It can be argued that a Technical Analyst need know nothing of market fundamentals, but we have found that a good balance between the two is the best approach.
PRICES MOVE IN TRENDS
If they did not, the market would consist of purely random movements. Inspection of almost any chart will show that this is clearly not the case. Trends do not, of course, establish and maintain a straight line. There is always interplay between market participants, a conflict between those who think the trend has further to go and those of the opposing view. This conflict produces the uncertainty during the trend.
HISTORY REPEATS ITSELF
In the Western world, markets have been charted for a hundred years or more, and certain patterns have been observed to occur frequently under similar market conditions. These patterns reflect the human response to situations, as human psychology does not really change. As the patterns have worked well in the past there is no reason to doubt that they will do so in the future. The driving forces behind markets are greed and fear. Under the influence of these forces human nature becomes less rational, and greed will drive prices to unsustainable levels, while fear will depress them below any reasonable valuation. One thing we have learnt is that the same mistakes and the same decisions are made time and time again. A depressing thought, but it provides the basis for technical analysis.
Technical analysis therefore should be used as a tool, not a black and white buy/sell signal. It is a subjective component to trading: there are no absolutely certain patterns and it is more of an indicator/confirmation tool than a precise clear-cut path to success.