In finance, technical analysis is an

analysis Analysis ( : analyses) is the process of breaking a complex topic or substance into smaller parts in order to gain a better understanding of it. The technique has been applied in the study of mathematics and logic since before Aristotle (38 ...

methodology for analysing and forecasting the direction of

prices A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the c ...

through the study of past market data, primarily price and volume.

Behavioral economics Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...

and quantitative analysis use many of the same tools of technical analysis, which, being an aspect of

active management Active management (also called ''active investing'') is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive man ...

, stands in contradiction to much of

modern portfolio theory Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversificatio ...

. The efficacy of both technical and

fundamental analysis Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements (usually to analyze the business's assets, liabilities, and earnings); health; and competitors and markets. It also considers the overall state ...

is disputed by the

efficient-market hypothesis The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted bas ...

, which states that stock market prices are essentially unpredictable, and research on whether technical analysis offers any benefit has produced mixed results.

History

The principles of technical analysis are derived from hundreds of years of

financial market A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets ...

data. Some aspects of technical analysis began to appear in Amsterdam-based merchant

Joseph de la Vega José or Joseph Penso de la Vega, best known as Josseph de la Vega (ca. 1650 — Amsterdam, 13 November, 1692), was a Sephardi Jewish merchant in diamonds, financial expert, moral philosopher and poet, residing in Amsterdam. He became famous for h ...

's accounts of the Dutch financial markets in the 17th century. In Asia, technical analysis is said to be a method developed by

Homma Munehisa (also known as Sokyu Honma or Sokyu Homma and sometimes called the God of markets ; 1724–1803) was a rice merchant from Sakata, Japan who traded in the Dōjima Rice Exchange in Osaka during the Tokugawa Shogunate. He is sometimes considered to ...

during the early 18th century which evolved into the use of candlestick techniques, and is today a technical analysis charting tool. Journalist

Charles Dow Charles Henry Dow (; November 6, 1851 – December 4, 1902) was an American journalist who co-founded Dow Jones & Company with Edward Jones and Charles Bergstresser. Dow also co-founded ''The Wall Street Journal'', which has become one of the ...

(1851-1902) compiled and closely analyzed American stock market data, and published some of his conclusions in editorials for

The Wall Street Journal ''The Wall Street Journal'' is an American business-focused, international daily newspaper based in New York City, with international editions also available in Chinese and Japanese. The ''Journal'', along with its Asian editions, is published ...

. He believed patterns and

business cycle Business cycles are intervals of Economic expansion, expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are ...

s could possibly be found in this data, a concept later known as "

Dow theory The Dow theory on stock price movement is a form of technical analysis that includes some aspects of sector rotation. The theory was derived from 255 editorials in ''The Wall Street Journal'' written by Charles H. Dow (1851–1902), journalist, f ...

". However, Dow himself never advocated using his ideas as a stock trading strategy. In the 1920s and 1930s, Richard W. Schabacker published several books which continued the work of

and

William Peter Hamilton William Peter Hamilton (January 20, 1867 – December 9, 1929), a proponent of Dow Theory, was the fourth editor of the ''Wall Street Journal'', serving in that capacity for more than 20 years (i.e., January 1, 1908 – December 9, 1929). ...

in their books ''Stock Market Theory and Practice'' and ''Technical Market Analysis''. In 1948, Robert D. Edwards and John Magee published ''Technical Analysis of Stock Trends'' which is widely considered to be one of the seminal works of the discipline. It is exclusively concerned with trend analysis and chart patterns and remains in use to the present. Early technical analysis was almost exclusively the analysis of charts because the processing power of computers was not available for the modern degree of statistical analysis. Charles Dow reportedly originated a form of

point and figure chart Point and figure (P&F) is a charting technique used in technical analysis. Point and figure charting does not plot price against time as time-based charts do. Instead it plots price against changes in direction by plotting a column of Xs as the p ...

analysis. With the emergence of behavioral finance as a separate discipline in economics, Paul V. Azzopardi combined technical analysis with behavioral finance and coined the term "Behavioral Technical Analysis". Other pioneers of analysis techniques include

Ralph Nelson Elliott Ralph Nelson Elliott (28 July 1871 – 15 January 1948) was an United States of America, American accountant and author, whose study of stock market data led him to develop the Elliott wave principle, Wave Principle, a description of the cyclical n ...

William Delbert Gann William Delbert Gann (June 6, 1878 – June 18, 1955) or WD Gann, was a finance trader who developed the technical analysis methods like the '' Gann angles'' and the ''Master Charts'', where the latter is a collective name for his various too ...

, and

Richard Wyckoff Richard Demille Wyckoff (November 2, 1873 – March 7, 1934) was an American stock market investor, and the founder and onetime editing, editor of the ''Magazine of Wall Street'' (founding it in 1907). He was also editor of ''Stock Market Techniq ...

who developed their respective techniques in the early 20th century. More technical tools and theories have been developed and enhanced in recent decades, with an increasing emphasis on computer-assisted techniques using specially designed

computer software Software is a set of computer programs and associated documentation and data. This is in contrast to hardware, from which the system is built and which actually performs the work. At the lowest programming level, executable code consists ...

General description

Fundamental analysts examine earnings, dividends, assets, quality, ratios, new products, research and the like. Technicians employ many methods, tools and techniques as well, one of which is the use of charts. Using charts, technical analysts seek to identify price patterns and

market trend A market trend is a perceived tendency of financial markets to move in a particular direction over time. Analysts classify these trends as ''secular'' for long time-frames, ''primary'' for medium time-frames, and ''secondary'' for short time-fram ...

s in financial markets and attempt to exploit those patterns.Murphy, John J. ''Technical Analysis of the Financial Markets''. New York Institute of Finance, 1999, pp. 1–5, 24–31. Technicians using charts search for archetypal price chart patterns, such as the well-known head and shoulders or double top/bottom reversal patterns, study

technical indicator In technical analysis in finance, a technical indicator is a mathematical calculation based on historic price, volume, or (in the case of futures contracts) open interest information that aims to forecast financial market direction. Technical indi ...

moving average In statistics, a moving average (rolling average or running average) is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. It is also called a moving mean (MM) or rolling mean and is ...

s and look for forms such as lines of support, resistance, channels and more obscure formations such as

flags A flag is a piece of fabric (most often rectangular or quadrilateral) with a distinctive design and colours. It is used as a symbol, a signalling device, or for decoration. The term ''flag'' is also used to refer to the graphic design employ ...

, pennants, balance days and

cup and handle In the domain of technical analysis of market prices, a cup and handle or cup with handle formation is a chart pattern consisting of a drop in the price and a rise back up to the original value, followed first by a smaller drop and then a rise past ...

patterns. Technical analysts also widely use market indicators of many sorts, some of which are mathematical transformations of price, often including up and down volume, advance/decline data and other inputs. These indicators are used to help assess whether an asset is trending, and if it is, the probability of its direction and of continuation. Technicians also look for relationships between price/volume indices and market indicators. Examples include the

relative strength index The relative strength index (RSI) is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading perio ...

and

MACD MACD, short for moving average convergence/divergence, is a trading indicator used in technical analysis of securities prices, created by Gerald Appel in the late 1970s. It is designed to reveal changes in the strength, direction, momentum, a ...

. Other avenues of study include correlations between changes in Options (

implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equa ...

) and put/call ratios with price. Also important are sentiment indicators such as Put/Call ratios, bull/bear ratios, short interest, Implied Volatility, etc. There are many techniques in technical analysis. Adherents of different techniques (for example: Candlestick analysis, the oldest form of technical analysis developed by a Japanese grain trader;

Harmonics A harmonic is a wave with a frequency that is a positive integer multiple of the ''fundamental frequency'', the frequency of the original periodic signal, such as a sinusoidal wave. The original signal is also called the ''1st harmonic'', the ...

;

; and Elliott wave theory) may ignore the other approaches, yet many traders combine elements from more than one technique. Some technical analysts use subjective judgment to decide which pattern(s) a particular instrument reflects at a given time and what the interpretation of that pattern should be. Others employ a strictly mechanical or systematic approach to pattern identification and interpretation.

Comparison with fundamental analysis

Contrasting with technical analysis is ''

'': the study of economic & other underlying factors that influence the way investors price financial markets. This may include regular corporate metrics like a company's recent

EBITDA A company's earnings before interest, taxes, depreciation, and amortization (commonly abbreviated EBITDA, pronounced , , or ) is a measure of a company's profitability of the operating business only, thus before any effects of indebtedness, stat ...

figures, the estimated impact of recent staffing changes to the

board of directors A board of directors (commonly referred simply as the board) is an executive committee that jointly supervises the activities of an organization, which can be either a for-profit or a nonprofit organization such as a business, nonprofit organiz ...

, geopolitical considerations, and even scientific factors like the estimated future effects of

global warming In common usage, climate change describes global warming—the ongoing increase in global average temperature—and its effects on Earth's climate system. Climate change in a broader sense also includes previous long-term changes to E ...

. Pure forms of technical analysis can hold that prices already reflect all the underlying fundamental factors. Uncovering future trends is what technical indicators are designed to do, although neither technical nor fundamental indicators are perfect. Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.

Comparison with quantitative analysis

The contrast against quantitative analysis is less clear cut than the distinction with fundamental analysis. Some sources treat technical and quantitative analysis as more or less synonymous. While others draw a sharp distinction. For example, quantitative analysis expert

Paul Wilmott Paul Wilmott (born 8 November 1959) is an English researcher, consultant and lecturer in quantitative finance.

Characteristics

Technical analysis employs models and trading rules based on price and volume transformations, such as the

s, regressions, inter-market, and intra-market price correlations,

stock market cycles ''See Business Cycle.'' Stock market cycles are proposed patterns that proponents argue may exist in stock markets. Many such cycles have been proposed, such as tying stock market changes to political leadership, or fluctuations in commodity pri ...

or classically, through recognition of chart patterns. Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. In the fundamental equation "M = P/E" technical analysis is the examination of M (multiple). Multiple encompasses the psychology generally abounding, i.e. the extent of willingness to buy/sell. Also in M is the ability to pay as, for instance, a spent-out

bull A bull is an intact (i.e., not castrated) adult male of the species ''Bos taurus'' (cattle). More muscular and aggressive than the females of the same species (i.e., cows), bulls have long been an important symbol in many religions, includin ...

can't make the market go higher and a well-heeled

bear Bears are carnivoran mammals of the family Ursidae. They are classified as caniforms, or doglike carnivorans. Although only eight species of bears are extant, they are widespread, appearing in a wide variety of habitats throughout the Nor ...

won't. Technical analysis analyzes price, volume, psychology, money flow, and other market information, whereas fundamental analysis looks at the facts of the company, market, currency, or commodity. Most large brokerages, trading groups, or financial institutions will typically have both a technical analysis and fundamental analysis team. In the 1960s and 1970s, it was widely dismissed by academics. In a 2007 review, Irwin and Park reported that 56 of 95 modern studies found that it produces positive results but noted that many of the positive results were rendered dubious by issues such as data snooping, so that the evidence in support of technical analysis was inconclusive; it is still considered by many academics to be indistinguishable from

pseudoscience Pseudoscience consists of statements, beliefs, or practices that claim to be both scientific and factual but are incompatible with the scientific method. Pseudoscience is often characterized by contradictory, exaggerated or falsifiability, unfa ...

. Academics such as

Eugene Fama Eugene Francis "Gene" Fama (; born February 14, 1939) is an American economist, best known for his empirical work on portfolio theory, asset pricing, and the efficient-market hypothesis. He is currently Robert R. McCormick Distinguished Servi ...

say the evidence for technical analysis is sparse and is inconsistent with the '' weak form'' of the

.Griffioen,
Technical Analysis in Financial Markets
' Users hold that even if technical analysis cannot predict the future, it helps to identify trends, tendencies, and trading opportunities. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987,Osler, Karen (July 2000). "Support for Resistance: Technical Analysis and Intraday Exchange Rates," FRBNY Economic Policy Review

. most academic work has focused on the nature of the anomalous position of the foreign exchange market. It is speculated that this anomaly is due to

central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...

intervention, which obviously technical analysis is not designed to predict.

Principles

A core principle of technical analysis is that a market's price reflects all relevant information impacting that market. A technical analyst therefore looks at the history of a security or commodity's trading pattern rather than external drivers such as economic, fundamental and news events. It is believed that price action tends to repeat itself due to the collective, patterned behavior of investors. Hence technical analysis focuses on identifiable price trends and conditions.

Market action discounts everything

Based on the premise that all relevant information is already reflected by prices, technical analysts believe it is important to understand what investors think of that information, known and perceived.

Prices move in trends

Technical analysts believe that prices trend directionally, i.e., up, down, or sideways (flat) or some combination. The basic definition of a price trend was originally put forward by

. An example of a security that had an apparent trend is AOL from November 2001 through August 2002. A technical analyst or trend follower recognizing this trend would look for opportunities to sell this security. AOL consistently moves downward in price. Each time the stock rose, sellers would enter the market and sell the stock; hence the "zig-zag" movement in the price. The series of "lower highs" and "lower lows" is a tell tale sign of a stock in a down trend.Kahn, Michael N. (2006). ''Technical Analysis Plain and Simple: Charting the Markets in Your Language'', Financial Times Press, Upper Saddle River, New Jersey, p. 80. . In other words, each time the stock moved lower, it fell below its previous relative low price. Each time the stock moved higher, it could not reach the level of its previous relative high price. Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that does not pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.

History tends to repeat itself

Technical analysts believe that investors collectively repeat the behavior of the investors that preceded them. To a technician, the emotions in the market may be irrational, but they exist. Because investor behavior repeats itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart. Recognition of these patterns can allow the technician to select trades that have a higher

probability Probability is the branch of mathematics concerning numerical descriptions of how likely an Event (probability theory), event is to occur, or how likely it is that a proposition is true. The probability of an event is a number between 0 and ...

of success. Technical analysis is not limited to charting, but it always considers price trends. For example, many technicians monitor surveys of investor sentiment. These surveys gauge the attitude of market participants, specifically whether they are

bearish Market sentiment, also known as investor attention, is the general prevailing attitude of investors as to anticipated price development in a market. This attitude is the accumulation of a variety of fundamental and technical factors, including p ...

bullish Market sentiment, also known as investor attention, is the general prevailing attitude of investors as to anticipated Market trends, price development in a market. This attitude is the accumulation of a variety of fundamental analysis, fundamenta ...

. Technicians use these surveys to help determine whether a trend will continue or if a reversal could develop; they are most likely to anticipate a change when the surveys report extreme investor sentiment. Surveys that show overwhelming bullishness, for example, are evidence that an uptrend may reverse; the premise being that if most investors are bullish they have already bought the market (anticipating higher prices). And because most investors ''are'' bullish and invested, one assumes that few buyers remain. This leaves more potential sellers than buyers, despite the bullish sentiment. This suggests that prices will trend down, and is an example of contrarian trading.

Industry

The industry is globally represented by the International Federation of Technical Analysts (IFTA), which is a federation of regional and national organizations. In the United States, the industry is represented by both the CMT Association and the American Association of Professional Technical Analysts (AAPTA). The United States is also represented by the Technical Security Analysts Association of San Francisco (TSAASF). In the United Kingdom, the industry is represented by the Society of Technical Analysts (STA). The STA was a founding member of IFTA, has recently celebrated its 50th Anniversary and certifies analysts with the Diploma in Technical Analysis. In Canada the industry is represented by the Canadian Society of Technical Analysts. In Australia, the industry is represented by the Australian Technical Analysts Association (ATAA), (which is affiliated to IFTA) and the Australian Professional Technical Analysts (APTA) Inc. Professional technical analysis societies have worked on creating a body of knowledge that describes the field of Technical Analysis. A body of knowledge is central to the field as a way of defining how and why technical analysis may work. It can then be used by academia, as well as regulatory bodies, in developing proper research and standards for the field. The

CMT Association The CMT Association is a non-profit, global, professional organization of technical analysts headquartered in New York City, servicing over 9,000 market analysis professionals in around 80 countries. The CMT Association certifies that an individual ...

has published a body of knowledge, which is the structure for the Chartered Market Technician (CMT) exam.

Software

Technical analysis software automates the charting, analysis and reporting functions that support technical analysts in their review and prediction of

s (e.g. the

stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...

). In addition to installable desktop-based software packages in the traditional sense, the industry has seen an emergence of cloud-based applications and application programming interfaces (APIs) that deliver technical indicators (e.g., MACD, Bollinger Bands) via RESTful HTTP or intranet protocols. Modern technical analysis software is often available as a web or a smartphone application, without the need to download and install a software package. Some of them even offer an integrated programming language and automatic backtesting tools.

Systematic trading

Neural networks

Since the early 1990s when the first practically usable types emerged,

artificial neural network Artificial neural networks (ANNs), usually simply called neural networks (NNs) or neural nets, are computing systems inspired by the biological neural networks that constitute animal brains. An ANN is based on a collection of connected unit ...

s (ANNs) have rapidly grown in popularity. They are

artificial intelligence Artificial intelligence (AI) is intelligence—perceiving, synthesizing, and inferring information—demonstrated by machines, as opposed to intelligence displayed by animals and humans. Example tasks in which this is done include speech re ...

adaptive software systems that have been inspired by how biological neural networks work. They are used because they can learn to detect complex patterns in data. In mathematical terms, they are universal function approximators, meaning that given the right data and configured correctly, they can capture and model any input-output relationships. This not only removes the need for human interpretation of charts or the series of rules for generating entry/exit signals, but also provides a bridge to fundamental analysis, as the variables used in fundamental analysis can be used as input. As ANNs are essentially non-linear statistical models, their accuracy and prediction capabilities can be both mathematically and empirically tested. In various studies, authors have claimed that neural networks used for generating trading signals given various technical and fundamental inputs have significantly outperformed buy-hold strategies as well as traditional linear technical analysis methods when combined with rule-based expert systems. While the advanced mathematical nature of such adaptive systems has kept neural networks for financial analysis mostly within academic research circles, in recent years more user friendly

neural network software Neural network software is used to simulate, research, develop, and apply artificial neural networks, software concepts adapted from biological neural networks, and in some cases, a wider array of adaptive systems such as artificial intelligence ...

has made the technology more accessible to traders.

Backtesting/Hindcasting

Systematic trading is most often employed after testing an investment strategy on historic data. This is known as

backtesting Backtesting is a term used in modeling to refer to testing a predictive model on historical data. Backtesting is a type of retrodiction, and a special type of cross-validation applied to previous time period(s). Financial analysis In a trading ...

(or

hindcasting Backtesting is a term used in modeling to refer to testing a predictive model on historical data. Backtesting is a type of retrodiction, and a special type of cross-validation applied to previous time period(s). Financial analysis In a trading ...

). Backtesting is most often performed for technical indicators combined with volatility but can be applied to most investment strategies (e.g. fundamental analysis). While traditional backtesting was done by hand, this was usually only performed on human-selected stocks, and was thus prone to prior knowledge in stock selection. With the advent of computers, backtesting can be performed on entire exchanges over decades of historic data in very short amounts of time. The use of computers does have its drawbacks, being limited to algorithms that a computer can perform. Several trading strategies rely on human interpretation, and are unsuitable for computer processing. Only technical indicators which are entirely algorithmic can be programmed for computerized automated backtesting.

Combination with other market forecast methods

John Murphy states that the principal sources of information available to technicians are price, volume and

open interest Open interest (also known as open contracts or open commitments) refers to the total number of outstanding derivative contracts that have not been settled (offset by delivery). For each buyer of a futures contract there must be a seller. From the t ...

. Other data, such as indicators and

sentiment analysis Sentiment analysis (also known as opinion mining or emotion AI) is the use of natural language processing, text analysis, computational linguistics, and biometrics to systematically identify, extract, quantify, and study affective states and subjec ...

, are considered secondary. However, many technical analysts reach outside pure technical analysis, combining other market forecast methods with their technical work. One advocate for this approach is John Bollinger, who coined the term ''rational analysis'' in the middle 1980s for the intersection of technical analysis and fundamental analysis. Another such approach, fusion analysis, overlays fundamental analysis with technical, in an attempt to improve portfolio manager performance. Technical analysis is also often combined with quantitative analysis and economics. For example, neural networks may be used to help identify intermarket relationships. Investor and newsletter polls, and magazine cover sentiment indicators, are also used by technical analysts.

Empirical evidence

Whether technical analysis actually works is a matter of controversy. Methods vary greatly, and different technical analysts can sometimes make contradictory predictions from the same data. Many investors claim that they experience positive returns, but academic appraisals often find that it has little

predictive power The concept of predictive power, the power of a scientific theory to generate testable predictions, differs from ''explanatory power'' and ''descriptive power'' (where phenomena that are already known are retrospectively explained or described ...

. Of 95 modern studies, 56 concluded that technical analysis had positive results, although

data-snooping bias Data dredging (also known as data snooping or ''p''-hacking) is the misuse of data analysis to find patterns in data that can be presented as statistically significant, thus dramatically increasing and understating the risk of false positives. T ...

and other problems make the analysis difficult. Nonlinear prediction using

neural networks A neural network is a network or circuit of biological neurons, or, in a modern sense, an artificial neural network, composed of artificial neurons or nodes. Thus, a neural network is either a biological neural network, made up of biological ...

occasionally produces

statistically significant In statistical hypothesis testing, a result has statistical significance when it is very unlikely to have occurred given the null hypothesis (simply by chance alone). More precisely, a study's defined significance level, denoted by \alpha, is the p ...

prediction results. A

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

working paper regarding

support and resistance In stock market technical analysis, support and resistance are certain predetermined levels of the price of a security at which it is thought that the price will tend to stop and reverse. These levels are denoted by multiple touches of price with ...

levels in short-term foreign exchange rates "offers strong evidence that the levels help to predict intraday trend interruptions", although the "predictive power" of those levels was "found to vary across the exchange rates and firms examined". Technical trading strategies were found to be effective in the Chinese marketplace by a recent study that states, "Finally, we find significant positive returns on buy trades generated by the contrarian version of the moving-average crossover rule, the channel breakout rule, and the Bollinger band trading rule, after accounting for transaction costs of 0.50%." An influential 1992 study by Brock et al. which appeared to find support for technical trading rules was tested for data snooping and other problems in 1999; the sample covered by Brock et al. was robust to data snooping. Subsequently, a comprehensive study of the question by Amsterdam economist Gerwin Griffioen concludes that: "for the U.S., Japanese and most Western European stock market indices the recursive out-of-sample forecasting procedure does not show to be profitable, after implementing little transaction costs. Moreover, for sufficiently high transaction costs it is found, by estimating

CAPM CAPM may refer to: * Capital asset pricing model, a fundamental model in finance * Certified Associate in Project Management, an entry-level credential for project managers {{Disambig ...

s, that technical trading shows no statistically significant risk-corrected out-of-sample forecasting power for almost all of the stock market indices." Transaction costs are particularly applicable to "momentum strategies"; a comprehensive 1996 review of the data and studies concluded that even small transaction costs would lead to an inability to capture any excess from such strategies. In a paper published in the ''

Journal of Finance ''The Journal of Finance'' is a peer-reviewed academic journal published by Wiley-Blackwell on behalf of the American Finance Association. It was established in 1946 and is considered to be one of the premier finance journals. The editor-in-chief ...

'', Dr. Andrew W. Lo, director MIT Laboratory for Financial Engineering, working with Harry Mamaysky and Jiang Wang found that: In that same paper Dr. Lo wrote that "several academic studies suggest that ... technical analysis may well be an effective means for extracting useful information from market prices." Some techniques such as Drummond Geometry attempt to overcome the past data bias by projecting support and resistance levels from differing time frames into the near-term future and combining that with reversion to the mean techniques.

Efficient-market hypothesis

The

(EMH) contradicts the basic tenets of technical analysis by stating that past prices cannot be used to profitably predict future prices. Thus it holds that technical analysis cannot be effective. Economist

published the seminal paper on the EMH in the ''Journal of Finance'' in 1970, and said "In short, the evidence in support of the efficient markets model is extensive, and (somewhat uniquely in economics) contradictory evidence is sparse." However, because future stock prices can be strongly influenced by investor expectations, technicians claim it only follows that past prices influence future prices.Aronson, David R. (2006)
''Evidence-Based Technical Analysis''
Hoboken, New Jersey: John Wiley and Sons, pages 357, 355–356, 342. . They also point to research in the field of

behavioral finance Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...

, specifically that people are not the rational participants EMH makes them out to be. Technicians have long said that irrational human behavior influences stock prices, and that this behavior leads to predictable outcomes. Author David Aronson says that the theory of behavioral finance blends with the practice of technical analysis:

By considering the impact of emotions, cognitive errors, irrational preferences, and the dynamics of group behavior, behavioral finance offers succinct explanations of excess market volatility as well as the excess returns earned by stale information strategies.... cognitive errors may also explain the existence of market inefficiencies that spawn the systematic price movements that allow objective TA echnical analysismethods to work.

EMH advocates reply that while individual market participants do not always act rationally (or have complete information), their aggregate decisions balance each other, resulting in a rational outcome (optimists who buy stock and bid the price higher are countered by pessimists who sell their stock, which keeps the price in equilibrium).Clarke, J., T. Jandik, and Gershon Mandelker (2001). "The efficient markets hypothesis," ''Expert Financial Planning: Advice from Industry Leaders'', ed. R. Arffa, 126–141. New York: Wiley & Sons. Likewise, complete information is reflected in the price because all market participants bring their own individual, but incomplete, knowledge together in the market.

Random walk hypothesis

The

random walk hypothesis The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk (so price changes are random) and thus cannot be predicted. History The concept can be traced to French broker Jules Regnault who pu ...

may be derived from the weak-form efficient markets hypothesis, which is based on the assumption that market participants take full account of any information contained in past price movements (but not necessarily other public information). In his book ''A Random Walk Down Wall Street'', Princeton economist

Burton Malkiel Burton Gordon Malkiel (born August 28, 1932) is an American economist and writer most noted for his classic finance book ''A Random Walk Down Wall Street'' (first published 1973, in its 12th edition as of 2019). He is a leading proponent of the ef ...

said that technical forecasting tools such as pattern analysis must ultimately be self-defeating: "The problem is that once such a regularity is known to market participants, people will act in such a way that prevents it from happening in the future." Malkiel has stated that while momentum may explain some stock price movements, there is not enough momentum to make excess profits. Malkiel has compared technical analysis to "

astrology Astrology is a range of Divination, divinatory practices, recognized as pseudoscientific since the 18th century, that claim to discern information about human affairs and terrestrial events by studying the apparent positions of Celestial o ...

".Robert Huebscher
Burton Malkiel Talks the Random Walk
7 July 2009. In the late 1980s, professors Andrew Lo and Craig McKinlay published a paper which cast doubt on the random walk hypothesis. In a 1999 response to Malkiel, Lo and McKinlay collected empirical papers that questioned the hypothesis' applicability that suggested a non-random and possibly predictive component to stock price movement, though they were careful to point out that rejecting random walk does not necessarily invalidate EMH, which is an entirely separate concept from RWH. In a 2000 paper,

Andrew Lo Andrew Wen-Chuan Lo () (born 1960) is the Charles E. and Susan T. Harris Professor of Finance at the MIT Sloan School of Management. Lo is the author of many academic articles in finance and financial economics. He founded AlphaSimplex Group in 1 ...

back-analyzed data from the U.S. from 1962 to 1996 and found that "several technical indicators do provide incremental information and may have some practical value". Burton Malkiel dismissed the irregularities mentioned by Lo and McKinlay as being too small to profit from. Technicians say that the EMH and random walk theories both ignore the realities of markets, in that participants are not completely rational and that current price moves are not independent of previous moves. Some signal processing researchers negate the random walk hypothesis that stock market prices resemble

Wiener process In mathematics, the Wiener process is a real-valued continuous-time stochastic process named in honor of American mathematician Norbert Wiener for his investigations on the mathematical properties of the one-dimensional Brownian motion. It is o ...

es, because the statistical moments of such processes and real stock data vary significantly with respect to window size and

similarity measure In statistics and related fields, a similarity measure or similarity function or similarity metric is a real-valued function that quantifies the similarity between two objects. Although no single definition of a similarity exists, usually such meas ...

. They argue that feature transformations used for the description of audio and

biosignal A biosignal is any signal in living beings that can be continually measured and monitored. The term biosignal is often used to refer to bioelectrical signals, but it may refer to both electrical and non-electrical signals. The usual understandin ...

s can also be used to predict stock market prices successfully which would contradict the random walk hypothesis. The random walk index (RWI) is a technical indicator that attempts to determine if a stock's price movement is random in nature or a result of a statistically significant trend. The random walk index attempts to determine when the market is in a strong uptrend or downtrend by measuring price ranges over N and how it differs from what would be expected by a random walk (randomly going up or down). The greater the range suggests a stronger trend. Applying Kahneman and Tversky's

prospect theory Prospect theory is a theory of behavioral economics and behavioral finance that was developed by Daniel Kahneman and Amos Tversky in 1979. The theory was cited in the decision to award Kahneman the 2002 Nobel Memorial Prize in Economics. Based ...

to price movements, Paul V. Azzopardi provided a possible explanation why fear makes prices fall sharply while greed pushes up prices gradually. This commonly observed behaviour of securities prices is sharply at odds with random walk. By gauging greed and fear in the market, investors can better formulate long and short portfolio stances.

Scientific technical analysis

Caginalp and Balenovich in 1994 used their asset-flow differential equations model to show that the major patterns of technical analysis could be generated with some basic assumptions. Some of the patterns such as a triangle continuation or reversal pattern can be generated with the assumption of two distinct groups of investors with different assessments of valuation. The major assumptions of the models are that the finiteness of assets and the use of trend as well as valuation in decision making. Many of the patterns follow as mathematically logical consequences of these assumptions. One of the problems with conventional technical analysis has been the difficulty of specifying the patterns in a manner that permits objective testing. Japanese candlestick patterns involve patterns of a few days that are within an uptrend or downtrend. Caginalp and Laurent were the first to perform a successful large scale test of patterns. A mathematically precise set of criteria were tested by first using a definition of a short-term trend by smoothing the data and allowing for one deviation in the smoothed trend. They then considered eight major three-day candlestick reversal patterns in a non-parametric manner and defined the patterns as a set of inequalities. The results were positive with an overwhelming statistical confidence for each of the patterns using the data set of all S&P 500 stocks daily for the five-year period 1992–1996. Among the most basic ideas of conventional technical analysis is that a trend, once established, tends to continue. However, testing for this trend has often led researchers to conclude that stocks are a random walk. One study, performed by Poterba and Summers, found a small trend effect that was too small to be of trading value. As Fisher Black noted, "noise" in trading price data makes it difficult to test hypotheses. One method for avoiding this noise was discovered in 1995 by Caginalp and Constantine who used a ratio of two essentially identical closed-end funds to eliminate any changes in valuation. A closed-end fund (unlike an open-end fund) trades independently of its net asset value and its shares cannot be redeemed, but only traded among investors as any other stock on the exchanges. In this study, the authors found that the best estimate of tomorrow's price is not yesterday's price (as the efficient-market hypothesis would indicate), nor is it the pure momentum price (namely, the same relative price change from yesterday to today continues from today to tomorrow). But rather it is almost exactly halfway between the two. Starting from the characterization of the past time evolution of market prices in terms of price velocity and price acceleration, an attempt towards a general framework for technical analysis has been developed, with the goal of establishing a principled classification of the possible patterns characterizing the deviation or defects from the random walk market state and its time translational invariant properties. The classification relies on two dimensionless parameters, the

Froude number In continuum mechanics, the Froude number (, after William Froude, ) is a dimensionless number defined as the ratio of the flow inertia to the external field (the latter in many applications simply due to gravity). The Froude number is based on t ...

characterizing the relative strength of the acceleration with respect to the velocity and the time horizon forecast dimensionalized to the training period. Trend-following and contrarian patterns are found to coexist and depend on the dimensionless time horizon. Using a renormalisation group approach, the probabilistic based scenario approach exhibits statistically significant predictive power in essentially all tested market phases. A survey of modern studies by Park and Irwin showed that most found a positive result from technical analysis. In 2011, Caginalp and DeSantis have used large data sets of closed-end funds, where comparison with valuation is possible, in order to determine quantitatively whether key aspects of technical analysis such as trend and resistance have scientific validity. Using data sets of over 100,000 points they demonstrate that trend has an effect that is at least half as important as valuation. The effects of volume and volatility, which are smaller, are also evident and statistically significant. An important aspect of their work involves the nonlinear effect of trend. Positive trends that occur within approximately 3.7 standard deviations have a positive effect. For stronger uptrends, there is a negative effect on returns, suggesting that profit taking occurs as the magnitude of the uptrend increases. For downtrends the situation is similar except that the "buying on dips" does not take place until the downtrend is a 4.6 standard deviation event. These methods can be used to examine investor behavior and compare the underlying strategies among different asset classes. In 2013, Kim Man Lui and T Chong pointed out that the past findings on technical analysis mostly reported the profitability of specific trading rules for a given set of historical data. These past studies had not taken the human trader into consideration as no real-world trader would mechanically adopt signals from any technical analysis method. Therefore, to unveil the truth of technical analysis, we should get back to understand the performance between experienced and novice traders. If the market really walks randomly, there will be no difference between these two kinds of traders. However, it is found by experiment that traders who are more knowledgeable on technical analysis significantly outperform those who are less knowledgeable.

Ticker-tape reading

Until the mid-1960s, tape reading was a popular form of technical analysis. It consisted of reading market information such as price, volume, order size, and so on from a paper strip which ran through a machine called a

stock ticker Ticker tape was the earliest electrical dedicated financial communications medium, transmitting stock price information over telegraph lines, in use from around 1870 through 1970. It consisted of a paper strip that ran through a machine called ...

. Market data was sent to brokerage houses and to the homes and offices of the most active speculators. This system fell into disuse with the advent of electronic information panels in the late 60's, and later computers, which allow for the easy preparation of charts.

Jesse Livermore Jesse Lauriston Livermore (July 26, 1877 – November 28, 1940) was an American stock trader. He is considered a pioneer of day trading and was the basis for the main character of '' Reminiscences of a Stock Operator'', a best-selling book by Ed ...

, one of the most successful stock market operators of all time, was primarily concerned with ticker tape reading since a young age. He followed his own (mechanical) trading system (he called it the 'market key'), which did not need charts, but was relying solely on price data. He described his market key in detail in his 1940s book 'How to Trade in Stocks'. Livermore's system was determining market phases (trend, correction etc.) via past price data. He also made use of volume data (which he estimated from how stocks behaved and via 'market testing', a process of testing market liquidity via sending in small market orders), as described in his 1940s book.

Quotation board

Another form of technical analysis used so far was via interpretation of stock market data contained in quotation boards, that in the times before electronic screens, were huge chalkboards located in the stock exchanges, with data of the main financial assets listed on exchanges for analysis of their movements. It was manually updated with chalk, with the updates regarding some of these data being transmitted to environments outside of exchanges (such as brokerage houses, bucket shops, etc.) via the aforementioned tape,

telegraph Telegraphy is the long-distance transmission of messages where the sender uses symbolic codes, known to the recipient, rather than a physical exchange of an object bearing the message. Thus flag semaphore is a method of telegraphy, whereas p ...

, telephone and later

telex The telex network is a station-to-station switched network of teleprinters similar to a Public switched telephone network, telephone network, using telegraph-grade connecting circuits for two-way text-based messages. Telex was a major method of ...

. This analysis tool was used both, on the spot, mainly by market professionals, as well as by general public through the printed versions in newspapers showing the data of the negotiations of the previous day, for swing and position trades.

Charting terms and indicators

Concepts

* Average true rangeaveraged daily trading range, adjusted for price gaps. * Breakoutthe concept whereby prices forcefully penetrate an area of prior

support Support may refer to: Arts, entertainment, and media * Supporting character Business and finance * Support (technical analysis) * Child support * Customer support * Income Support Construction * Support (structure), or lateral support, a ...

or resistance, usually, but not always, accompanied by an increase in volume. *

Chart pattern A chart pattern or price pattern is a pattern within a chart when prices are graphed. In stock and commodity markets trading, chart pattern studies play a large role during technical analysis. When data is plotted there is usually a pattern which n ...

distinctive pattern created by the movement of security or commodity prices on a chart * Cyclestime targets for potential change in price action (price only moves up, down, or sideways) *

Dead cat bounce In finance, a dead cat bounce is a small, brief recovery in the price of a declining stock. Derived from the idea that "even a dead cat will bounce if it falls from a great height", the phrase, which originated on Wall Street, is also popularly ap ...

the phenomenon whereby a spectacular decline in the price of a stock is immediately followed by a moderate and temporary rise before resuming its downward movement *

Elliott wave principle The Elliott Wave Principle, or Elliott wave theory, is a form of technical analysis that finance traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology and price levels, such as hi ...

and the

golden ratio In mathematics, two quantities are in the golden ratio if their ratio is the same as the ratio of their sum to the larger of the two quantities. Expressed algebraically, for quantities a and b with a > b > 0, where the Greek letter phi ( ...

to calculate successive price movements and retracements *

Fibonacci ratio In mathematics, the Fibonacci numbers, commonly denoted , form a sequence, the Fibonacci sequence, in which each number is the sum of the two preceding ones. The sequence commonly starts from 0 and 1, although some authors start the sequence from ...

sused as a guide to determine support and resistance and retracement percentages *

Momentum In Newtonian mechanics, momentum (more specifically linear momentum or translational momentum) is the product of the mass and velocity of an object. It is a vector quantity, possessing a magnitude and a direction. If is an object's mass an ...

the rate of price change * Point and figure analysisA priced-based analytical approach employing numerical filters which may incorporate time references, though ignores time entirely in its construction * Resistancea price level that may prompt a net increase of selling activity *

Support Support may refer to: Arts, entertainment, and media * Supporting character Business and finance * Support (technical analysis) * Child support * Customer support * Income Support Construction * Support (structure), or lateral support, a ...

a price level that may prompt a net increase of buying activity * Trendingthe phenomenon by which price movement tends to persist in one direction for an extended period of time

Types of charts

Candlestick chart A candlestick chart (also called Japanese candlestick chart or K-line) is a style of financial chart used to describe price movements of a security, derivative, or currency. It is similar to a bar chart in that each candlestick represents all f ...

Of Japanese origin and similar to OHLC, candlesticks widen and fill the interval between the open and close prices to emphasize the open/close relationship. In the West, often black or red candle bodies represent a close lower than the open, while white, green or blue candles represent a close higher than the open price. *

Line chart A line chart or line graph or curve chart is a type of chart which displays information as a series of data points called 'markers' connected by straight line segments. It is a basic type of chart common in many fields. It is similar to a s ...

Connects the closing price values with line segments. You can also choose to draw the line chart using open, high or low price. *

Open-high-low-close chart An open-high-low-close chart (also OHLC) is a type of chart typically used to illustrate movements in the price of a financial instrument over time. Each vertical line on the chart shows the price range (the highest and lowest prices) over one un ...

OHLC charts, also known as bar charts, plot the span between the high and low prices of a trading period as a vertical line segment at the trading time, and the open and close prices with horizontal tick marks on the range line, usually a tick to the left for the open price and a tick to the right for the closing price. *

Point and figure chart Point and figure (P&F) is a charting technique used in technical analysis. Point and figure charting does not plot price against time as time-based charts do. Instead it plots price against changes in direction by plotting a column of Xs as the p ...

a chart type employing numerical filters with only passing references to time, and which ignores time entirely in its construction.

Overlays

Overlays are generally superimposed over the main price chart. * Bollinger bandsa range of price volatility *

Channel Channel, channels, channeling, etc., may refer to: Geography * Channel (geography), in physical geography, a landform consisting of the outline (banks) of the path of a narrow body of water. Australia * Channel Country, region of outback Austral ...

a pair of parallel trend lines * Ichimoku kinko hyoa moving average-based system that factors in time and the average point between a candle's high and low *

Moving average In statistics, a moving average (rolling average or running average) is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. It is also called a moving mean (MM) or rolling mean and is ...

an average over a window of time before and after a given time point that is repeated at each time point in the given chart. A moving average can be thought of as a kind of dynamic trend-line. *

Parabolic SAR In stock and securities market technical analysis, parabolic SAR (parabolic stop and reverse) is a method devised by J. Welles Wilder, Jr., to find potential reversals in the market price direction of traded goods such as securities or currency exc ...

Wilder's trailing stop based on

tending to stay within a parabolic curve during a strong trend * Pivot pointderived by calculating the numerical average of a particular currency's or stock's high, low and closing prices * Resistancea price level that may act as a ceiling above price *

a price level that may act as a floor below price * Trend linea sloping line described by at least two peaks or two troughs * Zig ZagThis chart overlay that shows filtered price movements that are greater than a given percentage.

Breadth indicators

These indicators are based on statistics derived from the broad market. * Advance–decline linea popular indicator of

market breadth Breadth of market is an indicator used in security analysis Security analysis is the analysis of tradeable financial instruments called securities. It deals with finding the proper value of individual securities (i.e., stocks and bonds). These ...

. * McClellan Oscillator – a popular closed-form indicator of breadth. * McClellan Summation Index – a popular open-form indicator of breadth.

Price-based indicators

These indicators are generally shown below or above the main price chart. *

Average directional index The average directional movement index (ADX) was developed in 1978 by J. Welles Wilder as an indicator of trend strength in a series of prices of a financial instrument. ADX has become a widely used indicator for technical analysts, and is provided ...

a widely used indicator of trend strength. *

Commodity channel index The commodity channel index (CCI) is an oscillator originally introduced by Donald Lambert in 1980. Since its introduction, the indicator has grown in popularity and is now a very common tool for traders in identifying cyclical trends not only in c ...

identifies cyclical trends. *

convergence/divergence. *

the rate of price change. *

Relative strength index The relative strength index (RSI) is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading perio ...

(RSI)oscillator showing price strength. * Relative Vigor Index (RVI)oscillator measures the conviction of a recent price action and the likelihood that it will continue. *

Stochastic oscillator In technical analysis of securities trading, the stochastic oscillator is a momentum indicator that uses support and resistance levels. George Lane developed this indicator in the late 1950s. The term '' stochastic'' refers to the point of a cu ...

close position within recent trading range. * Trixan oscillator showing the slope of a triple-smoothed exponential

. * Vortex Indicatoran indicator used to identify the existence, continuation, initiation or termination of trends.

Volume-based indicators

Accumulation/distribution index The accumulation/distribution line or accumulation/distribution index in the stock market, is a technical analysis indicator intended to relate price and volume, which supposedly acts as a leading indicator of price movements. Formula : CLV = ...

based on the close within the day's range. *

Money flow index The money flow index (MFI) is an oscillator that ranges from 0 to 100. It is used to show the ''money flow'' (an approximation of the dollar value of a day's trading) over several days. The steps to calculate the money flow index over N days St ...

the amount of stock traded on days the price went up. *

On-balance volume On-balance volume (OBV) is a technical analysis indicator intended to relate price and volume in the stock market. OBV is based on a cumulative total volume. The formula : OBV = OBV_ + \left\{ \begin{matrix} volume & \mathrm{if}\ close > close_{ ...

the momentum of buying and selling stocks.

Trading with Mixing Indicators

& Super Trend *

*MACD & RSI *MACD & Moving Averages

References

Bibliography

* * * *

External links

;International and national organizations
International Federation of Technical Analysts
* Singapore
Technical Analysts Society (Singapore)
* United States
CMT Association
* United Kingdom
Society of Technical Analysts
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