Introduction to Technical Analysis
In its basic form, technical analysis is the study of prices in freely traded markets with the intent of making profitable trading or investment decisions. Consider the basic assumptions presented by Robert D. Edwards and John Magee in their classic book Technical Analysis of Stock Trends:
- Stock prices are determined solely by the interaction of demand and supply.
- Stock prices tend to move in trends.
- Shifts in demand and supply cause reversals in trends.
- Shifts in demand and supply can be detected in charts.
Many technical analysts have learned their trade from the mentors with whom they have worked. Numerous individuals who are interested in studying technical analysis today, however, do not have access to such a mentor. Thus, we wrote Technical Analysis: The Complete Resource for Financial Market Technicians. Our intent in writing the book was to provide the student of technical analysis with a systematic study of the field. Whether you are a novice college student or an experienced practitioner, our book provides a coherent and comprehensive summation of the body of knowledge that has developed in the field over the past 150 years. We have written this study guide to accompany the second edition of Technical Analysis. Its purpose is to assist students studying technical analysis for college coursework or professional examinations in organizing, reviewing, and measuring their comprehension of the subject matter.
Each chapter begins with a set of chapter objectives. These objectives provide concrete outcomes regarding topics you should understand and skills you should gain as you work your way through the chapter.
Next, we provide a summary of the chapter content. These chapter summaries present the major topics within a chapter, but they do not provide all the detailed information regarding those topics. You can think of them as a roadmap of the material, guiding you to the major stops you should make to discover more specifics regarding the material. For example, when you read the definition of a simple moving average in a chapter summary, this should spur you to recall the information in the chapter about how a shorter simple moving average adjusts more quickly to a change in trend than does a longer simple moving average.
Active learning is important whenever you are studying a subject such as technical analysis. You should study with pencil and paper in hand. Writing notes about new concepts as you come across them helps ensure that you understand the material and increases retention. We encourage you to interact with the material as much as possible. One of the best strategies for doing this is the time-tested method of outlining as you read. We suggest that you create an outline for each chapter as you read it. The headings and the subheadings within the chapters provide a guideline for points within your outline. Creating outlines helps you see how different parts of technical analysis fit together and provides an excellent method of organizing the material and your thoughts. In addition, as you go back to study and review the material later, you will find that your outlines provide quick reference to important points and guide you to the places in the textbook should you need to read more.
A thorough understanding of the vocabulary within a discipline is a prerequisite for comprehension of the material. In every chapter, we provide a section entitled “Key Concepts and Vocabulary” which contains vocabulary and concepts with which you might be unfamiliar. If you do not understand these terms, you will have difficulty with the material in the chapter. Some of these are technical terms, unique to the discipline of technical analysis. Others are terms with which you might be familiar in other contexts, but they have specific meaning within the field of technical analysis. We suggest that you keep a running list of definitions to form a glossary of terms to help you study or that you make flash cards with these terms.
Some of the material within the textbook requires the technician to make specific calculations. Other material requires the technician to be able to recognize quickly and easily particular patterns. Therefore, in some chapters we have provided a section entitled “Practice and Application.” This section provides an opportunity for you to interact with the material, working through calculations or sketching chart patterns. In doing these tasks, you move from a familiarity with the material to a working knowledge of the material.
Each chapter in Technical Analysis: The Complete Resource for Financial Market Technicians concludes with a series of end-of-chapter review questions. This study guide provides sample solutions for each of these questions. We would like to emphasize that it is through thinking about and constructing answers to the end-of-chapter questions that understanding occurs. In that sense, the “answer” to the question is not as important as the mental process of responding to the question. Although it might be tempting to jump straight to the answers and try to “learn” them, we strongly encourage you to construct your own answers first.
In some cases, the questions ask you to use market data when forming an answer. For these questions in particular, the final answer is not as important as the process of analyzing the data. For these questions, your answer might differ from the sample solution we have provided. First, if you are using a different period or a different security than what we have used to construct the sample response, your answer will be different. Second, even if you use the same security and period we consider, your answer might differ slightly. Different data sources differ slightly in their reporting of data; something as simple as differences in the number of decimal places reported can lead to a slightly different numerical answer in the end. Over time, these differences become magnified, as databases adjust historical prices not only for errors but for stock splits and dividends.
Finally, at the end of each chapter we provide a “self-test.” These self-tests are comprised of multiple-choice questions and are designed to enable you to assess your knowledge and comprehension of the subject matter. These questions are similar to questions you might encounter on Level 1 and Level 2 examinations for the Market Technician Association’s Chartered Market Technician (CMT) professional designation program. We designed these questions to give you a quick summary of your comfort level with the material in that chapter. These questions do not cover all the material in the chapter, and knowing the answers to these particular questions does not ensure thorough understanding of the material. Thus, these questions are not meant for “study;” they are meant for assessing your knowledge. A score of less than 80% on one of these self-tests is an indication that you need to spend more time studying the chapter to master the material contained in it. The answers to the self-test questions appear at the end of this study guide.
Learning any skill takes practice, practice, practice. Technical analysis is no different. Because technical analysis is the study of financial markets, the more involved you are with the financial markets on a daily basis, the more meaningful and productive your study of technical analysis will be. Watching the stock market and examining charts on a daily basis help you gain a familiarity with price behavior and enhance your ability to recognize traditional chart patterns. As with all things in life, the more you put into your study, the more you will get out of it.