Technical analysis is built upon the concept that the market could be timed efficiently by studying the various mechanisms of the marketplace at work, such as supply and demand, pricing cycles, along with other outside forces.
This is actually opposite of the random walk or modern portfolio theories, which presupposes that every stocks costs are unpredictable.
Technical analysts believe that by charting stock movements and looking for regularly occurring patterns or trends, the movement and cost of a stock can be predicted.
Technicians, also referred to as technical analysts, believe that the nature of the market is cyclical and therefore the best mechanism by which to examine movements is via charting.
This simple technique offers a visible representation of how stocks and moving averages act over a given period of time.
To obtain a moving average, 1 would take the last particular number of closing prices of a stock and then divide by that number.
For example, adding up the last ten closing costs of XYZ stock and then divide it by the number ten to produce that average.
The very next day, the closing price of day 1 is subtracted and also the closing cost of day 11 added to sum, again divided by ten.
These values are then charted and also the underlying trends noted.
Technicians primarily use two types of technical indicators, large picture and marketplace technical.
The first consists of trading action and also the Dow Theory.
The Dow Theory tracks the moving averages of two major indexes to examine to overall behavior, relative to changes between bull and bear markets.
It's not meant to be predictive, just to figure out when and why the change from strong to weak.
Trading action is another of the large picture indicators.
This assumes that the marketplace is cyclical and will repeat itself.
Therefore, it examines the movements and tries to discover underlying patterns.
One example of this is the Presidential Election Indicator, which claims that the third year of a President's term tends to be a much better market year simply because the election causes them to focus on improving the economy.
The second, marketplace technical indicators, examines different variables that drive marketplace behavior and uses these as predictive measures of future performance.
Four examples include; market volume, breadth of the market, short interest, and odd-lot trading-contrarian.
To measure these, graphs and charts pertinent to the variable can be created and studied.
Looking at market volume purely analyzes the supply and demand of stocks.
When the volume of stocks traded goes up, the market is strong.
When it goes down, it is weak.
Breadth of the market looks at the number of advancing securities, those whose costs are on the rise, to those that are declining to signify a change in overall market strength.
For instance, a narrowing spread could mean that strength is deteriorating and a bear market is beginning when advances outnumber declines.
Examination of short interest looks at the total number of shares being sold short to measure current optimism or pessimism.
A rising short sell trend would be indicative of a pessimistic, or weak, market.
And lastly, by looking at the number of odd-lots which are being traded, the volume of little traders could be measured.
Odd-lots are those which are not traded in amounts of 100.
This indicator assumes that small traders are doing the opposite of what ought to really be done.
Technicians, those who practice technical analysis, try and predict the actions of security prices by charting and studying the various variables at work in the marketplace.
They believe performance is largely cyclical and reliant on outside forces that will be determined.