Limited Time Offer: Save 10% on all 2022 Premium Study Packages with promo code: BLOG10

Technical Analysis (TA)

Technical Analysis (TA)

Technical analysis is the  use of price and volume data to value stocks. It upholds the idea that supply and demand collectively constitute market forces – ultimately determining the stock price. Technical analysis is a concept widely used to value securities in free markets around the globe.

Breaking Down Technical Analysis

A free market is one where willing buyers and willing sellers can interact without any inhibition. In such a market, traders are not  subjected to government impediments or some other form of constraint. Proponents of technical analysis argue that supply and demand determine stockprices in real-time.

Principles of Technical Analysis

Principles of Technical analysis are:

  1. The market discounts everything: It is considered that a financial instrument’s price reflects all of the factors that influence it.
  2. Price moves in trends and countertrends: Prices follow trends, and if a trend is identified, future price movement will be in line with it.
  3. Price action creates patterns that tend to recur and may, therefore, be cyclical. Market psychology is the reason price movements repeat themselves. Price changes can then be charted, thereby allowing technicians to spot patterns.

Assumptions of Technical Analysis

The following are the assumptions of Technical Analysis:

  1. All fundamental factors are priced into the stock price.
  2. Price movements follow particular trends (i.e. upward, downward, sideways, or a combination of these directions).
  3. The patterns and trends are repetitive and stem from market psychology. This  implies that the repetitive nature of price movements makes it possible to predict future price movements. 

Technical analysis deviates from the efficient market hypothesis, which claims humans always exercise rationality in decision-making and buying and selling financial assets. Technicians heavily link TA to the study of investor psychology and human behavior in different circumstances. Technicians believe that  evidence gathered over the years that shows that investors often respond  in the same manner when subjected to similar circumstances.

The Line Between Technical and Fundamental Analysis

While technical analysis values assets based on trading volume and pricing data, fundamental analysis is more conservative. Fundamental analysis values assets based on the information recorded in financial statements. To value a security, fundamental analysis looks into metrics such as the price-to-book value and company earnings before tax.

Applications of Technical Analysis

  1. Pricing of assets that do not have future cash flows (dividends or other forms of income).
  2. Analysts can use the method to estimate fair values of assets in situations where financial statements are fraudulent, effectively ruling out the reliability of the fundamental analysis.

The analysis of trading volumes and price fluctuations is done graphically and displayed in the form of charts. For this reason, technical analysis is widely considered easier to conduct and interpret  compared to fundamental analysis.

IIt is imperative to note that  using past data and trends to predict  a market’s future may not always be valid. We cannot rely on the past as an accurate indicator of future results.

Question

Which of the following is least likely an assumption inherent in technical analysis?

  1. Patterns and trends are non-repetitive.
  2. Supply and demand determine the value of assets.
  3. Rational and irrational forces drive supply and demand.

Solution

The correct answer is A.

According to technical analysis, patterns and trends are repetitive.

Other assumptions inherent in technical analysis are:

  • All fundamental factors are priced into the stock price.
  • Price movements follow particular trends (i.e. upward, downward, sideways, or a combination of these directions).
  • The patterns and trends are repetitive and stem from market psychology. This  implies that the repetitive nature of price movements makes it possible to predict future price movements. 
Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop GMAT® Exam Prep


    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.