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Charting or technical analysis is the use of numerical series generated by market activity, such as price and volume traded, to predict future trends in that market. The techniques can be applied to any market with a comprehensive price history. Technical analysis does not try to analyze the financial data of a company, such as cashflow, dividends, and projection of future dividends; because of this lack of fundamental analysis, technical analysis is controversial and derided by critics as being akin to looking into a crystal ball .
While technical analysis is widely used (if only as one input among many) by both professional and amateur traders as a means of predicting future market moves, it is generally not used by economists in any academic sense.
Technical analysis implicitly rejects the efficiency of the market as understood in the efficient market hypothesis (EMH). That is, using technical analysis on a particular market implicitly assumes that that market is not efficient, as defined by EMH. The efficient markets theories basically argue that existing prices reflect all available information, and that future price movements will follow a path that will approximate to a random walk ( Brownian motion) as they adjust to new information as it emerges. The theories further assume that all participants in the stock market have equal and instantaneous access to all information that might affect stocks.
Technical analysts, or chartists, believe that by analysing stock price histories, they can discern sufficient information about the thinking of buyers and sellers to anticipate future events. The assumption is that there is useful information to be gleaned, hidden within price histories; that technical analysis is a way of analyzing the past actions of the people participating in a particular market, as reflected by their actual transactions. As the assumption of an efficient market is central to almost all option pricing theory, financial mathematicians working in the area of derivatives generally reject technical analysis as unscientific. All large investment banks, however, employ both technical analysts and financial mathematicians.
Critics say that technical analysis is no better than mystic divination cloaked in numbers and mumbo jumbo. It has been noted that technical analysis entirely failed to predict the bursting of the dot com bubble, and by its very nature could never have predicted it. Many of the worst offenders predicting future stock price growth at the peak of that bubble were technical analysts. Critics also note that there are no known billionaire technical analysts, presumably because in the long term the techniques of technical analysis do not work.
The traditional chartists developed familiarity with chart patterns that seemed to recur repeatedly and gave some of them names, e.g. " head and shoulders " or " flag " or " triangle ". They believed that they could infer probabilities of price action from studying the patterns.
More recent technical analysts use a wide variety of techniques but, at their best, their methods approximate more closely to a statisticalStatistics is the science and practice of developing human knowledge through the use of empirical data. It is based on statistical theory which is a branch of applied mathematics. Within statistical theory, randomness and uncertainty are modelled by proba analysis of price action. For example, J.M. Hurst (see below) used sophisticated techniques ( Fourier analyses) to search for meaningful signalA signal may refer to: an abstract element of information, or, more exactly, usually a flow of information (in either one or several dimensions). See Signal (information theory . in electronics) a signal is any physical phenomenon that can be modeled as as amongst the apparent random noise of stock price movements.
The most sophisticated technical analysis software allows the user to design indicators and to optimise them by testing their profitability (assuming trading rules and transactions costs) using historic data; trading stratagems can be designed that utilise one or more such indicators.
Some of the techniques used and patterns found include:
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