Formal definition

• Technical analysis is a method of forecasting the direction of

prices through the study of past market data, primarily price and
volume.

The study of market action based on four premises

Human behavior is
Market action
Prices move in History repeats in at least somewhat
discounts the
trends a general manner consistent over
future
time

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The study of technical analysis

• In general terms, technical analysts:

• Study charts to uncover patterns

• Apply indicators to identify trends

• Use relative strength to identify potential outperformers

• Study cycles to spot potential turning points in advance

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Many fundamental ratios incorporate price into
calculations

• Price-to-earnings (P/E) ratio is obviously dependent on

price.
• Same is true of P/S, P/B, P/CF, etc…

• Dividend yield is determined by price.

dividend amount ($) / current price ($)

• The state of fundamental ratios (overvalued or

undervalued) are understood in terms that are similar for
technical indicators (overbought or oversold).

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Fundamental and Technical Indicators Often
Disagree

As prices rise, value

investors find the stock
more attractive.

Rising dividend yield shows increasing value.

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Assumptions of Technical Analysis

• Price is determined by supply and demand.

• Price discounts everything and the price of the security contains all
the information that’s available about that security.
• Prices move in trends.
• Trends can exist in varying time frames from intraday to multi-year.
• History repeats itself .
• This is because human nature is unchanging -- reactions to internet stocks
in 2000 is similar to reactions to tulip bulbs in 1637.
• Emotional decisions are affected by previous emotional decisions.
• This explains technical concepts like support and resistance, for example,
and behavioral finance concepts like loss aversion.

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TA Can Be Applied To Free and Liquid Markets

• To apply TA:
• Markets must be free and open, meaning free from
price manipulation and open to informed participants.

• Liquid so buyers and sellers can immediately execute

orders.

• Market data must be widely available.

• Assets are substitutable which means an analysis of the

stock is applicable to all shares of a stock. This is also
called fungibility.

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