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1.
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Definition
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"Technical analysis is the study of market action, primarily through
the use of charts, for the purpose of forecasting future price
trends.". In its purest form, technical analysis considers only the
actual price behavior of the market or instrument, based on the
premise that price reflects all relevant factors before an investor
becomes aware of them through other channels.
Technical analysis is widely used among traders and financial
professionals, and some studies say its use is more widespread than
is "fundamental" analysis in the foreign exchange market. Academics
such as Eugene Fama say the evidence for technical analysis is
sparse and is refuted by the efficient market hypothesis, yet some
Federal Reserve and academic studies include evidence that supports
technical analysis. MIT finance professor Andrew Lo argues that
"several academic studies suggest that…technical analysis may well
be an effective means for extracting useful information from market
prices."Burton Malkiel argues, "Technical analysis is anathema to
the academic world."
Other Resources:
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The Globe And Mail:
A method of evaluating future security prices and market
directions based on statistical analysis of variables such as
trading volume, price changes, etc., to identify patterns.
More…
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Cambridge Mercantile Corp.:
is analysis based on market action through chart study, volume,
trends, moving averages, patterns, formations and many other
technical indicators.
More…
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Charter FX:
Analysis applied to the price action of the market to
develop trading decisions, irrespective of fundamental factors.
More…
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Comerica:
Is concerned with past price and volume trends and often with
the help of chart analysis in a market in order to be able to
make forecasts about future price developments of the commodity
being traded.
More…
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Market Traders Institute:
An effort to forecast future market activity by analyzing market
data such as charts, price trends, and volume.
More…
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Oanda FXTrade:
Studying charts that display the historic behavior of market
data/statistics (price open, high, low and close, volume, open
interest, etc.) in order to forecast future performance.
More…
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The Atlus Group:
A form of market analysis that studies demand and supply for
securities and commodities based on trading volume and price
studies.
More…
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Edward Jones:
The study of supply and demand of securities based on price and
trading volume trends.
More…
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Freebuck:
Technical analysts study trading histories to identify price
trends in particular stocks, mutual funds, commodities, or
options in specific market sectors or in the overall financial
markets.
More…
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2.
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Examples, Types, or
Variations
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Technical analysts believe that prices trend. Technicians say that
markets trend up, down, or sideways (flat). This basic definition of
price trends is the one put forward by Dow Theory.
An example of a security that had an apparent trend is AOL from
November 2001 through August 2002. A technical analyst or trend
follower recognizing this trend would look for opportunities to sell
this security. AOL consistently moves downward in price. Each time
the stock rose, sellers would enter the market and sell the stock;
hence the "zig-zag" movement in the price. The series of "lower
highs" and "lower lows" is a tell tale sign of a stock in a down
trend. In other words, each time the stock edged lower, it fell
below its previous relative low price. Each time the stock moved
higher, it could not reach the level of its previous relative high
price.
Note that the sequence of lower lows and lower highs did not begin
until August. Then AOL makes a low price that doesn't pierce the
relative low set earlier in the month. Later in the same month, the
stock makes a relative high equal to the most recent relative high.
In this a technician sees strong indications that the down trend is
at least pausing and possibly ending, and would likely stop actively
selling the stock at that point.
Widely-known technical analysis concepts include:
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Accumulation/distribution index—based on the close within the
day's range
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Average true range - averaged daily trading range
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Bollinger bands - a range of price volatility
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Breakout - when a price passes through and stays above an area
of support or resistance
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Commodity Channel Index - identifies cyclical trends
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Elliott wave principle and the golden ratio to calculate
successive price movements and retracements
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Hikkake Pattern - pattern for identifying reversals and
continuations
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MACD - moving average convergence/divergence
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Momentum - the rate of price change
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Money Flow - the amount of stock traded on days the price went
up
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Moving average - lags behind the price action
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On-balance volume - the momentum of buying and selling stocks
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PAC charts - two-dimensional method for charting volume by price
level
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Parabolic SAR - Wilder's trailing stop based on prices tending
to stay within a parabolic curve during a strong trend
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Pivot point - derived by calculating the numerical average of a
particular currency's or stock's high, low and closing prices
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Point and figure charts - charts based on price without time
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Profitability - measure to compare performances of different
trading systems or different investments within one system
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Relative Strength Index (RSI) - oscillator showing price
strength
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Resistance - an area that brings on increased selling
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Rahul Mohindar Oscillator - a trend identifying indicator
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Stochastic oscillator, close position within recent trading
range
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Support - an area that brings on increased buying
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Trend line - a sloping line of support or resistance
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Trix - an oscillator showing the slope of a triple-smoothed
exponential moving average, developed in the 1980s by Jack
Hutson
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3.
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Formula
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4.
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Related Terms
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Dow
Theory
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Technical Indicator
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Bollinger Bands
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Chartist
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Market Timing
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Fundamental Analysis
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Empirical Evidence
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Moving Average
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5.
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As
Used in the Hedge Fund World
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Many
non-arbitrage algorithmic trading systems rely on the idea of
trend-following, as do many hedge funds. A relatively recent trend,
both in research and industrial practice, has been the development
of increasingly sophisticated automated trading strategies. These
often rely on underlying technical analysis principles.
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6.
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Applications
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Other Resources:
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Wikipedia:
Technical
analysis believes that investors en masse display much of the
same behavior as the investors that preceded them. "Everyone
wants in on the next Microsoft," "If this stock ever gets to $50
again, I will buy it," "This company's technology will
revolutionize its industry, therefore this stock will
skyrocket,"--these are all examples of investors' attitudes
repeating. To a technical analyst, the human characteristics of
the market might be irrational but nonetheless they exist.
Because investors' attitudes often repeat, investors' actions in
the marketplace often repeat as well. I.e., patterns of price
movement will develop on a chart that a technical analyst
believes have predictive qualities.
It is important to understand that the realm of technical
analysis is not limited to charting. Technical analysis is
always primarily concerned with price trends. Anything that can
influence the price trend is of interest to a technical analyst.
As an example, many technical analysts monitor surveys of
investor enthusiasm. These surveys attempt to gauge the general
attitude of the investment community to determine whether
investors are
bearish
or
bullish.
Technical analysts use these surveys to help determine whether a
trend will reverse or whether a new trend will develop. A
technical analyst would be alerted that a trend might change
when these surveys report extreme investor reactions. When
surveys are overly bullish, for example, a technical analyst
will look for evidence that an uptrend will reverse. The logic
being that if most investors are bullish, then they would have
already bought the market (anticipating that the market will
move higher). But because most investors are bulllish and have
invested, it is safe to assume that there are few buyers
remaining in the market. With most investors
long,
there are more potential sellers in the market than buyers
despite the fact that the overall attitude of investors is
bullish. This implies that the market is set to trend down and
is an example of a technical analysis concept called
contrarian trading.
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7.
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Misused & Abused
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The Wall
Street Journal Europe states "Whether technical analysis is really
useful ... is a matter of some dispute on Wall Street. Some
investors believe that it is impossible to forecast the market's ups
and downs. Academic studies have shown that when most people,
professionals and amateurs alike, try to move money in and out of
stocks to beat market fluctuations, they tend to wind up with
losses." The same article shows how several technical analysts can
simultaneously make contradictory predictions.
Critics of technical analysis include well known fundamental
analysts. For example, Peter Lynch once commented, "Charts are great
for predicting the past." Warren Buffett has said, "I realized
technical analysis didn't work when I turned the charts upside down
and didn't get a different answer" and "If past history was all
there was to the game, the richest people would be librarians."
Some academic studies say technical analysis has little predictive
power, but other studies say it may produce excess returns. For
example, measurable forms of technical analysis, such as non-linear
prediction using neural networks, have been shown to occasionally
produce statistically significant prediction results. A Federal
Reserve working paper regarding support and resistance levels in
short-term foreign exchange rates "offers strong evidence that the
levels help to predict intraday trend interruptions," although the
"predictive power" of those levels was "found to vary across the
exchange rates and firms examined."
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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