Technical Analysis Fundamentals
While fundamental analysis asks "What should this security be worth?", technical analysis takes a completely different approach: it studies past price and volume data to predict where prices are headed next.
What Is Technical Analysis?
- Studies past market data (primarily price and volume) to forecast future price movements
- Technical analysts are sometimes called chartists
- Does NOT analyze financial statements or intrinsic value (that is fundamental analysis)
Three Core Assumptions
- Market action discounts everything: all known information (fundamental, political, psychological) is already reflected in the price
- Prices move in trends: trends tend to persist until a clear reversal occurs
- History repeats itself: chart patterns recur because market psychology is consistent over time
These assumptions mean technical analysts believe studying price action alone gives you everything you need to make trading decisions.
Exam Tip: Gotchas
- Technical analysis ignores financial statements entirely. It only looks at price and volume. If a question mentions analyzing balance sheets or earnings, that is fundamental analysis.
Trend Lines
The foundation of technical analysis is identifying the direction of a trend.
| Trend | Pattern | How to Draw |
|---|---|---|
| Uptrend (bullish) | Higher highs and higher lows | Connect the lows with a trend line |
| Downtrend (bearish) | Lower highs and lower lows | Connect the highs with a trend line |
| Sideways/horizontal | Prices move within a range | No clear direction; draw horizontal lines at the range boundaries |
- A trend remains in effect until it is broken by price action crossing the trend line
- The longer a trend persists, the more significant its eventual break becomes
Exam Tip: Gotchas
- An uptrend line is drawn along the LOWS (not the highs). A downtrend line is drawn along the HIGHS (not the lows).
- Trends persist until broken. A reversal requires price action crossing the trend line, not just slowing momentum.
Support and Resistance Levels
| Concept | Definition | Acts As |
|---|---|---|
| Support level | Price where buying pressure prevents further decline | A "floor" for the stock price |
| Resistance level | Price where selling pressure prevents further advance | A "ceiling" for the stock price |
Key Principles
- The more times a support or resistance level is tested and holds, the more significant it becomes
- A breakout occurs when the price moves decisively through a support or resistance level
- Role reversal: When support is broken, it often becomes new resistance (and vice versa)
Exam Tip: Gotchas
- When support is broken, it flips to become resistance (and vice versa). This "role reversal" concept is frequently tested.
Think of it this way: Once buyers stop defending a price level (support breaks), sellers now defend it from below (it becomes resistance).