Technical Analysis

The Three Premises

Technical analysis sits on three assumptions, first laid out by Charles Dow — co-founder of Dow Jones & Company and the Wall Street Journal — in the late 1800s.

The market discounts everything. Every public input — earnings, news, macro data, and a fair amount of insider knowledge — is already baked into the current price. The quote on the screen is the aggregate read of every participant in the auction at that moment.

Prices move in trends. A stock moving up tends to keep moving up. A stock moving down tends to keep moving down. Trends hold until the supply-and-demand balance flips. Spotting the trend and trading with it is the most basic rule of technical work.

History repeats. Patterns on a chart come from human behavior — fear, greed, hope, regret. That behavior has not changed much across decades, so the same patterns show up in 1929, 1987, 2008, and 2020 with only the tickers changing.

Reading a Price Chart

The standard chart format is the candlestick. Each candle records four data points for the period: open, close, high, low. A green or white candle means the close was above the open. A red or black candle means the close was below the open. The body shows the open-to-close range. The thin lines above and below the body, called wicks or shadows, mark the period’s high and low.

Most traders work in more than one timeframe. A swing trader might use the weekly chart for the major trend, the daily for the entry, and the hourly for timing. A day trader runs the same logic on the daily, 15-minute, and 5-minute charts. The principle is the same at every scale: confirm the bigger trend first, then drop down to find the entry.

Trends

Identifying the trend is the single most important skill in technical work. There are three.

Uptrend — higher highs and higher lows. Each pullback bottoms above the prior pullback. The stock is making upward progress.

Downtrend — lower highs and lower lows. Each rally tops below the prior rally. The stock is in decline.

Sideways or range-bound — price oscillates between a defined [[support and resistance|support]] level (floor) and resistance level (ceiling) without sustained progress in either direction.

The old saying “the trend is your friend” survives because trading with the trend has been measurably more profitable than trading against it. Buying a stock in an uptrend puts momentum on the trader’s side. Shorting one in a downtrend puts gravity on the trader’s side. Counter-trend trades are possible, but the math does not favor them.

Tools and Indicators

Technical traders use dozens of indicators. Most fall into three families: trend, momentum, and volume. A practical setup combines one from each rather than stacking five trend tools that all repeat the same information.

Trend Indicators

The moving average is the most widely used trend tool. A moving average smooths price by averaging it over a fixed number of periods. The 50-day and the 200-day are the two everyone watches. Price holding above its moving average reads as bullish; price below it reads as bearish. A “golden cross” is the 50-day crossing above the 200-day, read as a bullish signal. A “death cross” is the reverse and reads as bearish. (I’ve traded both signals and the daily 50/200 cross on the major indices is the version that has actually paid — the same cross on individual small-caps prints too late to be useful.)

Momentum Indicators

The RSI (Relative Strength Index) and the [[MACD]] (Moving Average Convergence Divergence) measure the speed and strength of price movement. RSI runs from 0 to 100; readings above 70 are conventionally called overbought, readings below 30 oversold. Strong trends can hold an RSI above 70 for weeks, so the indicator is more useful for divergence than for absolute thresholds. MACD tracks the relationship between two moving averages and produces buy or sell signals when its component lines cross.

Volume Indicators

[[Understanding Volume|Volume]] confirms or contradicts price action. A breakout on heavy volume — meaning a session printing 150% or more of the 30-day average — is more reliable than one on light volume. A rally on declining volume is running out of fuel. Volume is what sustains a trend; without it, the move stalls.

Chart Patterns

Technical analysts study the recurring formations that price draws on a chart. These signal either continuation, where the existing trend resumes, or reversal, where the trend changes direction. The core patterns are:

• [[Head and Shoulders Pattern|Head and Shoulders]] — the most cited reversal pattern, marking a shift from uptrend to downtrend on a confirmed neckline break.
• [[Double Bottom]] — a W-shaped reversal at the end of a downtrend, confirmed when price clears the middle peak.
• [[Cup and Handle]] — a bullish continuation built on a rounded base followed by a tight, slightly downward-drifting handle.
• Triangles — converging trendlines that compress price until a breakout resolves them in one direction.
• Flags and Pennants — small consolidations inside strong trends, usually resolving in the direction of the prior move.

Our Chart Patterns section covers each of these with concrete entry, stop, and exit examples.

Limitations

Technical analysis has its critics, and their objections deserve a fair hearing.

Self-fulfilling prophecy. Some argue patterns work only because enough traders believe in them and act on them. There is something to that, but the practical effect is the same: if a large enough crowd acts on a signal, price moves regardless of why.

No edge in efficient markets. The Efficient Market Hypothesis holds that past prices carry no information about future prices. The academic record on this is mixed, and decades of profitable technical traders suggest the hypothesis is, at minimum, incomplete in its strong form.

Curve fitting. Given enough indicators and enough parameters, patterns can be found in any dataset, including random noise. Disciplined traders use a small set of tested tools and resist the urge to keep adding more.

In practice, many traders use technical analysis as the primary timing tool while leaning on [[Fundamental Analysis|fundamental analysis]] for stock selection. The fundamentals point to what is worth trading. The technicals point to when.

See also: [[Fundamental Analysis]] · [[Head and Shoulders Pattern]] · [[Understanding Volume]] · [[Position Sizing and Risk Management|Risk Management]]