There exist today an array of charts, patterns and statistical analyses sufficient to please even a Medieval numerologist. Though it often looks and reads a lot like mathematical tea-leaf reading, most of the frequently used tools use serious empirical studies with the markets.
The best way to explain what Technical Analysis is could possibly be to contrast it with its arch-rival and sometimes partner: Fundamental Analysis.
Fundamental analysis tries to consider a financial instrument (a stock, bond, etc) by taking a look at factors affecting intrinsic worth. Company earnings, basic industry issues – everything from the overall economy to who sits in the Chief Financial Officer’s chair.
Technical analysis shys away from measurements of things like assets and liabilities and company or industry details. It looks instead for statistical patterns among historical (both recent and far past) price movements, volume of stock traded and a multitude of other variables.
Next parameters and patterns appear arcane to many but the specialists. Fortunately there are a few basic ones acceptable for the savvy but nonetheless merely mortal.
Probably the most basic may be the simple bar chart. Used for years and years in one form or another, it consists of the recognizable vertical stick with small horizontal tick marks included.
The length of the bar shows the price range of the instrument for a current period – usually the last 24 hours or the trading day up to that point. The horizontal mark on the right indicates the starting price, the left-pointing one shows the closing price.
A series of these presented across a chart – for periods of a week, a month, quarterly, etc – forms a pattern. It’s that pattern that the technical analyst uses (to some extent) to forecast the way the pattern will continue on – i.e. what the price is going to be an hour or a day or a month hence.
Traders who rely heavily on technical analysis are seldom long term players. Somewhat like forecasting the rain, a set of data might help you figure with high probability what could happen in the immediate future. It’s less useful for judging the result 90 days ahead.
Candlesticks – adapted from the Japanese, where they were employed to forecast rice futures – undoubtedly are a common variation. The change consists essentially of ‘fattening’ the vertical stick and adding color to indicate variations between opening and closing quotes.
Red strips are used to confirm a closing price lower than the previous period, green when the instrument closed higher. Consistently, distinct shapes suggest – to the initiated – different market trends.
Since options, like bonds, add the element of time expiration unique variables to forecast signs come into play. Also, since as a derivative an option has no intrinsic worth, price and volume changes can (and do) occur as a result of changes to the underlying asset.
Several of the variables that evaluate these changes make their way into technical analysis charts.
Delta, for example, measures how much an option price rises or falls relative to the change in price of the underlying asset. Theta measures how much an options position gains or loses in a period of time – a day, a week, a month, etc. Vega is a measure of how much a position gains or loses as volatility changes by a specified percentage.
Luckily for us, there are software packages on the market that will enable tracking of these and other variables. Algorithms are built in that experts assert indicate thresholds and patterns that accurately indicate buy or sell.
Given that there are dozens of such offerings, incorporating hundreds of different variables and patterns, only experience will show you which ones are significant and which ones are only numerology.
