Stock Market Technical Analysis Explained
Introduction to Technical Analysis
Reading the Charts
Imagine trying to predict the weather. You could study meteorology, atmospheric pressure, and global wind patterns. Or, you could just look outside at the clouds. Technical analysis is a lot like looking at the clouds. It's a method of forecasting the direction of prices by studying past market data, primarily price and trading volume.
Technical analysts aren't concerned with a company's earnings or its leadership. They believe all that information is already baked into the stock's price. The only thing that matters is the price itself and how it's moving.
This approach is different from fundamental analysis, which digs into a company's financial health to determine its actual value. A fundamental analyst might read financial statements for hours. A technical analyst will spend that time studying a price chart.
Think of it this way: fundamental analysis helps you decide what to buy, while technical analysis helps you decide when to buy it.
Put simply, we use fundamental analysis to find what stocks to trade, and we use technical analysis to determine when and how to trade them.
The Three Core Beliefs
Technical analysis is built on three core ideas. Understanding them is key to understanding the mindset of a technical trader.
- The market discounts everything.
This is the cornerstone. Technical analysts believe that everything that can possibly affect a stock's price—from earnings reports and product launches to broader economic news—is already reflected in its current market price.
There's no need to analyze all those separate factors because the price is the ultimate summary. All you need to do is analyze the price itself.
Since all information is already reflected in the price, technical analysts focus solely on price charts, believing that they need not look elsewhere to make informed trading decisions.
- Prices move in trends.
Stock prices don't move randomly. They tend to move in trends, which can be upward, downward, or sideways. The main goal of technical analysis is to identify the direction of a market trend and catch a ride. Once a trend is established, the price is more likely to continue in that direction than to move against it.
- History tends to repeat itself.
This final principle is all about market psychology. The financial markets are driven by people, and people tend to react in consistent ways to similar situations. Over decades of trading, certain chart patterns have emerged that reflect these predictable human emotions of fear and greed.
Technical analysts study these historical patterns to find clues about where the price might go next. Because human nature doesn't change much, these patterns often lead to similar outcomes time and time again.
At its core, technical analysis is based on the idea that historical price action tends to repeat itself due to market psychology.
By focusing on price action and the patterns it creates, technical analysis offers a distinct way to approach the market, turning charts into a language for understanding supply and demand.