INTRODUCTION - Technical Analysis
Should I buy today? What will prices be tomorrow, next week, or next year? Wouldn't investing be
easy if we knew the answers to these seemingly simple questions? Alas, if you are taking this class in
the hope that technical analysis has the answers to these questions, I'm afraid I have to disappoint
you early--it doesn't. However, if you are reading this class with the hope that technical analysis will
improve your investing, I have good news--it will!
Technical Analysis is the study of past price and activity history in order to predict future price
movements. The basic premises of technical analysis is that the price discounts all information
available in the market and that patterns in price movements tend to repeat themselves.
Another important foundation of technical analysis is that price movements are not random, but tend to
trend in some direction most of the time. Although this seems as an obvious fact to anybody that has
ever looked at a chart, it is in fact a hotly disputed idea in certain academic circles. But then again,
maybe that is why they are academics rather than traders.
The term "technical analysis" is a complicated sounding name for a very basic approach to investing.
Simply put, technical analysis is the study of prices, with charts being the primary tool.
The roots of modern-day technical analysis stem from the Dow Theory, developed around 1900 by
Charles Dow. Stemming either directly or indirectly from the Dow Theory, these roots include such
principles as the trending nature of prices, prices discounting all known information, confirmation and
divergence, volume mirroring changes in price, and support/resistance. And of course, the widely
followed Dow Jones Industrial Average is a direct offspring of the Dow Theory.
Charles Dow's contribution to modern-day technical analysis cannot be understated. His focus on the
basics of security price movement gave rise to a completely new method of analyzing the markets.
The human element
The price of a security represents a consensus. It is the price at which one person agrees to buy and
another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his
expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to
fall, he will sell it. These simple statements are the cause of a major challenge in forecasting security
prices, because they refer to human expectations. As we all know firsthand, humans are not easily
quantifiable nor predictable. This fact alone will keep any mechanical trading system from working
Because humans are involved, I am sure that much of the world's investment decisions are based on