Too embarrassed to ask: what is technical analysis?

Some investors don’t rely on a market or company’s fundamentals when assessing whether to buy or sell. They use “technical analysis” or “charting” instead. But what exactly is technical analysis?

There are two main approaches to investing in asset markets. One is to look at what are known as “the fundamentals” – for example, you might look at a company’s accounts to see how profitable it is, and to work out how much you should be willing to pay for it. You might also look at the wider backdrop – is the economy growing or weakening? What impact might that have on the sector?  However, there is another popular way to invest that ignores all of this entirely – that’s “technical analysis”, often referred to as “charting”. This involves looking at price charts to forecast the likely direction of the price of an asset. 

As far as hardcore technical analysts are concerned, all of the information you could possibly need to make an investment decision is already reflected in current prices. In other words, anything you can glean from “the fundamentals” has already been priced in. However, while there is always a flow of new information coming into markets, investors react to this new information in predictable ways. And because markets are cyclical, this results in recurring patterns of buyer and seller behaviour, which in turn will show up as recurring patterns on the charts. Being able to identify these patterns as they occur gives technical analysts an insight into what might happen next. 

In effect, technical analysis is built on an understanding that markets are driven by human greed and fear as much as they are by things like profitability and balance sheet strength.

Technical analysts employ a whole range of indicators and different types of chart. The simplest approach focuses on the idea that prices tend to “trend”, moving up,  down or sideways for long periods of time. So, for example, the path of least resistance for a stock that is moving up is to keep moving up. So a technical analyst might, for example, use moving averages – that is, plotting a line which takes the average of the asset price over a set number of trading days – to identify trends, and to measure how powerful they are.

Technical analysis may not sound very scientific, and like any other market approach, whether it “works” or not depends on who you ask and when you ask them. But its main purpose is to enable short-term traders to define clear entry and exit points for trades, which is something that fundamental analysis simply cannot do.  

To learn more about investing methods, subscribe to MoneyWeek magazine.

Recommended

Where will house prices go in 2023?
House prices

Where will house prices go in 2023?

We explore what could happen to house prices in 2023 as the market continues to slow down.
24 Mar 2023
What is inflation and how will it affect you?
Inflation

What is inflation and how will it affect you?

There has been much talk of inflation recently. But what exactly is it and what does it mean for our money?
24 Mar 2023
3 success stories set for long-term growth
Investments

3 success stories set for long-term growth

A professional investor tells us where he’d put his money. This week: Felix Wintle, manager of the VT Tyndall North American Fund, selects three favou…
24 Mar 2023
Share tips of the week – 24 March
Investments

Share tips of the week – 24 March

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages
24 Mar 2023

Most Popular

Bank of England hikes key interest rate to 4.25%
UK Economy

Bank of England hikes key interest rate to 4.25%

The Bank of England raised rates by 0.25% following a surprise jump in inflation.
23 Mar 2023
Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

Ofgem’s price cap is now predicted to fall below £2,000, based on average typical use, from July, for the first time since 2022. We have all the detai…
21 Mar 2023
When will interest rates go up?
UK Economy

When will interest rates go up?

The Bank of England raised rates to 4.25%, its 11th consecutive increase. Does the base rate have further to go?
23 Mar 2023