New to Charting and Technical Analysis? Get answers to commonly asked questions from the one of the industry's foremost authorities on technical analysis.

Q: What is Technical Analysis?

A: Technical Analysis is the study and analysis of "hard" data produced by the financial markets - price and volume mainly. The primary tools of Technical Analysis are a chart (of price and volume) and a ruler.

The chart not only shows where the price has been but gives some idea of where it will go. The ruler is used to determine entry and exit points. Prophet charts may easily be substituted for the physical tools.




Q: How is it different from Fundamental Analysis?

A: First let's discriminate between "technical" and "fundamental" data. Technical data is data which is generated by the action of the market under study. It is "hard" data. "Soft" data, or data which can be manipulated by its producers, such as sales, earnings, expenses, etc. is the subject of Fundamental Analysis, the other main school of analyzing financial markets. Fundamentalists are often disdainful of technical analysts. And vice versa.

According to Bob Prechter, a well known analyst most renowned for his writing and practice with the Elliott Wave Theory, "The main problem with fundamental analysis is that its indicators are removed from the market itself. The analyst assumes causality between external events and market movements, a concept which is almost certainly false. But, just as important, and less recognized, is that fundamental analysis almost always requires a forecast of the fundamental data itself before conclusions about the market are drawn. The analyst is then forced to take a second step in coming to a conclusion about how those forecasted events will affect the markets! Technicians only have one step to take, which gives them an edge right off the bat. Their main advantage is that they don't have to forecast their indicators."

Technicians largely ignore fundamental data, considering it to be misleading. They concentrate on the hard data, usually presenting it in the form of bar charts.

This does not mean they ignore fundamental questions. On the contrary, good traders pay attention to any input which might be price influencing. But they do not allow any other inputs -news, fundamentals, opinions - to overrule their analysis of an instrument's chart.




Q: Why does Technical Analysis work?

A: Certain patterns tend to be repeated year after year in all publicly traded financial instruments, such as head and shoulders tops, or double tops, or rounding bottoms, or triangles. The recognition of these patterns, and of trends and support and resistance is a qualitative, or judgmental process, but the existence of trends is undisputable. Many recurring patterns have been identified and comprehensively described by Edwards and Magee, the best known practitioners of the craft.

On the quite philosophical side, technical analysis works because it is a tautological method, meaning self-fulfilling. For example, no bull market in history ever became a bear market without breaking its long term trendlines.




Q: Trendlines? Mathematical studies? Are there different schools of technical analysis?

A: There are various schools of technical analysis: Classical, or Chart Analysts, P&F, Elliott Wave, Wyckoff, and Statistical, or Number Driven Analysis. I am primarily a chart analyst and I also pay attention to number driven analysis - and anything else including the phases of the moon! - which I think will aid in properly analyzing the market.

Chart Analysts work on the price and volume chart of an instrument to find support and resistance and trends. In this process they identify patterns of price behavior which by past experience have marked support and resistance and trading and trending action. Trend lines are drawn on a chart to indicate trading ranges and trends and consolidation and continuation patterns.

Statistical or Number Driven Technical Analysts use mathematical algorithms (moving averages, oscillators, and other indicators) to identify support and resistance and trends. Their preferred method is to create mechanical and objective systems which eliminate emotionalism and judgment from the trading process.

There is a huge variety of mathematical indicators. Some are used to find overbought or oversold securities. Some measure the strength of stock's momentum in a certain direction; changes in the price direction.




Q: Does TA work for only certain markets? Stocks versus futures?

A: Chart analysis and technical analysis will work for any market. I have used it in trading bonds, commodities, stocks and for scoffing at government economic projections.

I don't have a technical background, and I don't want to spend a lot of time reading books. Can TA still help my trading? How can I get started?

It is a public misconception that the use of technical analysis requires a college degree in mathematics or statistics. A moderately intelligent little old lady with a chart and ruler often proves to be a more effective investor than any number of Nobel Prize Laureates put together.

My latest book, Zen Simple: - Beat the Market With a Ruler" is written for investors who don't want to learn the hows and whys of technical studies. Instead, Zen Simple gives you the foundation to conduct a simple qualitative analysis using trendlines to identify profitable patterns, set stops and price targets.

These methods are highly effective used on their own, and they can also be used in conjunction with confirming studies.

Discuss TA Basic Questions and Answers in our forum - Strategy Central Board.