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Share Investing - Technical Analysis

Falling WedgeTechnical Analysis of prices, or charting, is the process of analysing graphs or charts of price and volume movements to determine the direction prices are likely to move. It is not confined to shares but can be used with any traded security or commodity.

In contrast to fundamental analysis, which analyses economic and financial factors in order to establish a price, technical analysis can be said to be analysing what investors think of the various factors influencing a price and how they are likely to react to it.

Technical analysis has been around for centuries. One of the most famous names associated with technical analysis is Charles Dow (1851-1902) who was the co-founder and editor of Dow Jones & Company which published the Wall Street Journal and invented the Dow Jones Industrial Average. "The Dow" is the most widely know US stock market index. After his death Dow's writings were collated and presented as "Dow Theory" although Dow himself never used the term nor presented it as a trading theory.

Technical analysts believe that investors collectively repeat the behavior of the investors that preceded them. To a technician, the emotions in the market may be irrational, but they exist. Because investor behavior repeats itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart.

Many studies have tried to prove or disprove that technical analysis can reliably predict price movements, the jury is still out but many Academics dismiss technical analysis as a "pseudoscience" and put it in the same basket as astrology. But the fact remains that many people use it and many claim it works. Technical analysis is widely used by share traders and is particularly prevalent in the foreign exchange markets.

LooCup and Handleking at historical charts it is easy to see patterns and see where prices started rising or falling, it is an awful lot harder to look at the current picture and say what will happen next.

With the advent of computers sophisticated formulae could be applied to large collections of data and analysed very quickly. Later the near instantaneous collection and transmission of data allowed completely computerised trading programs to be developed that buy and sell securities based on the patterns in the data the computer has been programmed to recognise.

As a long term investor I tend to rely largely on fundamental analysis and reserve technical analysis for helping with the timing the buying or selling of a share. In the long run I believe value will show through. No matter what the technical signals might be showing I wouldn't invest in a share I believed had poor fundamentals. However if I have identified that a share I am holding can no longer justify it's price on fundamentals I will consider the technical charts when deciding whether to sell now or wait for a bit. One proviso on that, if I need the money in the immediate future for something else I always sell now, you never know what might happen tomorrow.

There are technical analysis theories that claim to be able to predict price movements over the very long term

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