Reframing Technical Analysis

When you Google “technical analysis” the definition that is presented initially (from Investopedia) is:

“Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities in price trends and patterns seen on charts. Technical analysts believe past trading activity and price changes of a security can be valuable indicators of the security's future price movements.” 

This is the definition that most people adhere to.  Many people, maybe even you, until now, have thought of technical analysis as a guessing game where technical analysts (in many eyes de facto traders) look at charts and draw lines all day to explain past and possible future price movement.  While this is not inherently 100% incorrect it certainly should be reframed.

I present you my definition, which may be yours, simply reframed:

Technical analysis, when applied to a market, is the study of supply and demand using price charts.

That is it.  It does not need to be overcomplicated.  There are trends and patterns that we study that do present themselves from time to time, but these trends and patterns are based on the underlying supply and demand.  Every price change in the market is composed of someone buying and someone selling. 

During any day on the most-popular candlestick chart of a particular security, the following occurs:

  1. A buyer is paying the opening price while a seller is selling at the opening price.
  2. At one point, a buyer will pay the most for the security for the day, and the associated seller will get the best price for the security for this day.
  3. At one point, a buyer will pay the best price for the security for the day, and the associated seller will be paid the lowest for selling the security for this day.
  4. The day will close and the last recorded trade between a buyer and seller will be recorded.

These four data points go into a candlestick graph and are what most technical analysis will be based on.  The chart makes this information more digestible, but at the end of the day it is still all about buyers and sellers, a market, and supply and demand. 

Supply and demand drive price change.  Are you incorporating enough technical analysis?

Related: Offsetting Client 401(k)s