13.5 Technical Analysis

Explore the essentials of technical analysis within the Canadian Securities Course (CSC). Understand the tools and assumptions that technical analysts utilize to determine future price trends based on historical market data.

Technical Analysis

Tools Used in Technical Analysis

Technical analysis focuses on analyzing historical market action to determine probable future price trends. Unlike fundamental analysts, who study a broad range of data, technical analysts consider this data too vast and unwieldy to accurately pinpoint price movements. Instead, they direct their attention to the market itself, whether it pertains to commodities, equities, interest rates, or foreign exchange. They plot the past and present movements of prices, the trading volume, and statistical indicators onto charts. In the equity markets, for example, analysts track the number of advancing and declining stocks. These activities aim to identify recurrent and predictable patterns that can be used to forecast future price movements.

Market Action: Primary Sources of Information

Market action includes three primary sources of information:

  1. Price
  2. Volume
  3. Time

Key Assumptions of Technical Analysis

Technical analysis is grounded on three key assumptions regarding these sources of information:

1. Price Discounts Everything

Technical analysts believe all known market influences are fully and automatically accounted for or discounted in market prices. They assert there is limited advantage to be gained from fundamental analysis since all necessary insights can be derived from the price action itself. By examining price action, technicians seek to measure market sentiment and expectations. The belief here is that the market itself indicates the direction and extent of its next price move.

Given that prices move in identifiable trends, which persist over relatively long periods, the primary task of a technical analyst is to identify a trend in its early stages. Analysts carry positions in that direction until evidence suggests the trend is reversing.

3. Historical Patterns Repeat

The assumption here is that historical price movements tend to repeat themselves due to the market psychology inherent in investor behavior. Technical analysts look for patterns and signals that have proven to be reliable over time.

    graph TD
	    A[Technical Analysis Assumptions]
	    A --> B[1. Price Discounts Everything]
	    A --> C[2. Prices Move in Trends]
	    A --> D[3. Historical Patterns Repeat]
	
	    C -->|Uptrend| E[Prolonged Period Ascending]
	    C -->|Downtrend| F[Prolonged Period Descending]
	
	    E --> G[Trend Identification: Buy Signal]
	    F --> H[Trend Identification: Sell Signal]
	
	    style B fill:#f9f,stroke:#000,stroke-width:2px
	    style C fill:#bbf,stroke:#000,stroke-width:2px
	    style D fill:#bff,stroke:#000,stroke-width:2px
	    style E fill:#cfc,stroke:#000,stroke-width:2px
	    style F fill:#fcc,stroke:#000,stroke-width:2px
	    style G fill:#9f9,stroke:#000,stroke-width:2px
	    style H fill:#f99,stroke:#000,stroke-width:2px

History Repeats Itself

Technical analysts hold the view that markets are reflections of investor psychology and that the behavior of investors tends to repeat itself. Investors can fluctuate between emotions such as pessimism, fear, panic, optimism, greed, and euphoria.

By comparing the current investor behavior, as reflected through market action, to historical market behavior, analysts make informed predictions. Even if history doesn’t repeat itself exactly, valuable lessons can still be learned from the past movements.

Key Takeaways

  • Technical analysts focus on charts that display historical market actions including price trends, trading volumes, and statistical indicators.
  • The three primary sources of information in technical analysis are price, volume, and time.
  • The fundamental assumptions of technical analysis include: price discounts everything, prices move in trends, and history repeats itself.
  • The ultimate goal is to use these patterns to forecast future market movements by understanding and anticipating market psychology.

Frequently Asked Questions (FAQs)

  1. What is technical analysis? Technical analysis is the study of past market data, primarily price and volume, to forecast future price movements based on observed historical trends and patterns.

  2. Why do technical analysts focus less on fundamental data? Technical analysts believe that all known fundamental information is already reflected in the price of securities, making the study of market price movements more informative.

  3. How do technical analysts identify a trend? Analysts use charts displaying past price movements, looking for sustained patterns of ascension (uptrend) or declination (downtrend). Once identified, they follow this trend until signs of reversal appear.

  4. Do technical analysis predictions always hold true? While not infallible, technical analysis provides a useful heuristic framework. Given the repetitive nature of market behavior, it increases the probability of accurately forecasting future price movements.

Glossary

  • Technical Analysis: A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume.
  • Fundamental Analysis: A method of evaluating securities by attempting to measure their intrinsic value, made through examining related economic, financial, and other qualitative and quantitative factors.
  • Trend: The general direction in which something tends to move; in finance, this often pertains to the movement of price.
  • Trading Volume: The quantity of shares, contracts, or lots traded in a security or an entire market during a given period.

Canadian Securities Course | Volume 2


📚✨ CSC Exam Bank ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What is the primary focus of technical analysis? - [ ] Fundamental analysis - [ ] Economic indicators - [x] Historical market action - [ ] Corporate financial reports > **Explanation:** Technical analysts prioritize historical market action to determine probable future price trends. They believe all market influences are reflected in prices. ## Which market attributes does technical analysis consider? - [x] Price, volume, time - [ ] Economic growth, inflation, employment - [ ] Earnings, dividends, book value - [ ] Market capitalization, liquidity, profitability > **Explanation:** Technical analysis is based on three primary sources of information: price, volume, and time. ## What is the belief regarding market prices among technical analysts? - [ ] Only fundamental analysis can predict price movements - [ ] Prices are influenced by unknown factors - [x] All known market influences are reflected in market prices - [ ] Prices follow random paths > **Explanation:** Technical analysts believe that all known market influences are reflected in market prices and that studying price action itself is sufficient for market analysis. ## What is a primary task of a technical analyst based on their assumptions? - [ ] To calculate intrinsic value of stocks - [x] To identify trends in their early stages - [ ] To forecast economic conditions - [ ] To evaluate corporate governance > **Explanation:** A primary task of technical analysts is to identify trends in their early stages and carry positions in that direction until the trend reverses itself. ## How do technical analysts view investor psychology? - [ ] As an unimportant factor - [ ] As a predictable and controllable variable - [x] As causing market behaviours that tend to repeat over time - [ ] As being too erratic to be useful in market analysis > **Explanation:** Technical analysts believe markets reflect investor psychology and that investor behaviours tend to repeat themselves over time. ## What is the main reason technical analysts believe studying historical market trends is useful? - [ ] To understand company valuations - [ ] To predict political events - [x] Because investor behaviour that creates these trends tends to repeat itself - [ ] To control market volatility > **Explanation:** Technical analysts believe that investor behaviour repeats itself, making historical market trends valuable for predicting future price moves. ## What types of markets do technical analysts study? - [ ] Only equity markets - [ ] Only commodity markets - [ ] Only foreign exchange markets - [x] Equity, commodity, foreign exchange, and interest rate markets > **Explanation:** Technical analysts study various types of markets, including equity, commodity, foreign exchange, and interest rate markets, to identify patterns for predicting future price movements. ## According to technical analysis, what is market action primarily comprised of? - [ ] Corporate earnings, dividends, and new product launches - [x] Price, volume, and time - [ ] Economic policy, international trade, and consumer sentiment - [ ] Industry performance, sector performance, and macroeconomic trends > **Explanation:** Market action in technical analysis is primarily comprised of price, volume, and time. ## What does technical analysis assume about trends? - [ ] Trends do not exist in financial markets - [ ] Trends are short-lived and unpredictable - [x] Trends tend to persist for relatively long periods of time - [ ] Trends are only influenced by external economic factors > **Explanation:** One assumption of technical analysis is that price trends exist and tend to persist for relatively long periods of time. ## What is the purpose of plotting data on charts in technical analysis? - [ ] To improve investment company branding - [x] To identify recurrent and predictable patterns - [ ] To compare with fundamental data - [ ] To adjust for inflation rates > **Explanation:** In technical analysis, plotting data on charts helps identify recurrent and predictable patterns that can be used to anticipate future price moves.

📢
Exciting News!

🚀 Launch Date: April 14th

🎉 Now On App Store!

📱 Available on iPhone and iPad

📚 Master the CSC® Exam with our top ranked iOS app! Packed with thousands of sample questions, it's your perfect study companion for acing the Canadian Securities Course Certification exams!

🎯 Achieve Your Professional Goals with ease. Try it now and take the first step towards success!

🌟 CSC Exam Questions 🌟

✨ Download Today! ✨

In this section

Tuesday, July 23, 2024