The basics of technical analysis is the study of past financial market data, primarily through the use of charts, to forecast price trends and make investment decisions.

In its purest form, technical analysis considers only the actual price behavior of the market or instrument, based on the premise that price reflects all relevant factors before an investor becomes aware of them through other channels.

Technical analysts (or technicians) identify non-random price patterns and trends in financial markets and attempt to exploit those patterns.

While technicians use various methods and tools, the study of price charts is primary. Technicians especially search for archetypal patterns, such as the well-known head and shoulders reversal pattern, and also study such indicators as price, volume, and moving averages of the price.

Many technical analysts also follow indicators of investor psychology (market sentiment).

Technicians seek to forecast price movements such that large gains from successful trades exceed more numerous but smaller losing trades, producing positive returns in the long run through proper risk control and money management.

There are several schools of basics of technical analysis. Adherents of different schools (for example, candlestick charting, Dow Theory, and Elliott wave theory)may ignore the other approaches, yet many traders combine elements from more than one school.

Technical analysts use judgment gained from experience to decide which pattern a particular instrument reflects at a given time, and what the interpretation of that pattern should be.

Technical analysts may disagree among themselves over the interpretation of a given chart.

Basics of technical analysis is frequently contrasted with fundamental analysis, the study of economic factors that some analysts say can influence prices in financial markets.

Pure technical analysis holds that prices already reflect all such influences before investors are aware of them, hence the study of price action alone.

Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.

Principles of basics of technical analysis

Technicians say that a market's price reflects all relevant information, so their analysis looks more at "internals" than at "externals" such as news events.

Price action also tends to repeat itself because investors collectively tend toward patterned behavior -- hence technicians' focus on identifiable trends.

Market action discounts everything

Based on the premise that all relevant information is already reflected by prices, technical analysts believe it is redundant to do fundamental analysis -- they say news and news events do not significantly influence price.

On most of the sizable return days [large market moves]…the information that the press cites as the cause of the market move is not particularly important. Press reports on adjacent days also fail to reveal any convincing accounts of why future profits or discount rates might have changed.

Our inability to identify the fundamental shocks that accounted for these significant market moves is difficult to reconcile with the view that such shocks account for most of the variation in stock returns.

History tends to repeat itself

Technical analysts believe that investors collectively repeat the behavior of the investors that preceded them.

"Everyone wants in on the next Microsoft" "If this stock ever gets to $50 again, I will buy it," "This company's technology will revolutionize its industry, therefore this stock will skyrocket"

These are all examples of investor sentiment repeating itself. To a technician, the emotions in the market may be irrational, but they exist.

Because investor behavior does repeat itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart.

Basics of technical analysis is not limited to charting, yet is always concerned with price trends.

For example, many technicians monitor surveys of investor sentiment. These surveys gauge the attitude of market participants, specifically whether they are bearish or bullish.

Technicians use these surveys to help determine whether a trend will continue or if a reversal could develop; they are most likely to anticipate a change when the surveys report extreme investor sentiment.

Surveys that show overwhelming bullishness, for example, are evidence that an uptrend may reverse -- the premise being that if most investors are bullish they have already bought the market (anticipating higher prices). And because most investors are bullish and invested, one assumes that few buyers remain.

This leaves more potential sellers than buyers, despite the bullish sentiment. This suggests that prices will trend down, and is an example of contrarian trading.

Though former Federal Reserve Chairman Alan Greenspan has not described himself as a technical analyst, he has said that the history of investor behavior appears to repeat itself:

"…there is one important caveat to the notion that we live in a new economy, and that is human psychology. The same enthusiasms and fears that gripped our forebears, are, in every way, visible in the generations now actively participating in the American economy. Human actions are always rooted in a forecast of the consequences of those actions... To be sure, the degree of risk aversion differs from person to person, but judging the way prices behave in today's markets compared with those of a century or more ago, one is hard pressed to find significant differences.

The way we evaluate assets, and the way changes in those values affect our economy, do not appear to be coming out of a set of rules that is different from the one that governed the actions of our forebears…. As in the past, our advanced economy is primarily driven by how human psychology molds the value system that drives a competitive market economy. And that process is inextricably linked to human nature, which appears essentially immutable and, thus, anchors the future to the past."

Now we'll move on from basics of technical analysis to the first chapter of this section: The "stocks charts"