Technical Analysis Basics

⏱️ 9 min read Beginner Level 1: Foundations

Technical analysis studies price charts and patterns to predict future movements. While academically controversial—efficient market theory says it shouldn't work—practitioners claim success. Understanding the basics helps you evaluate its merits for yourself.

Core Principles

1. Price discounts everything: All information (fundamentals, news, sentiment) is reflected in price

2. Prices move in trends: Trends persist until clear reversal signals

3. History repeats: Patterns recur because human psychology is consistent

Chart Types

Line Charts

Connect closing prices. Simple, clean, but hides intraday action.

Bar Charts

Show open, high, low, close (OHLC) for each period. More information than line charts.

Candlestick Charts

Visual representation of OHLC. Green/white = close above open (bullish), red/black = close below open (bearish). Most popular among traders.

Support and Resistance

Support: Price level where buying pressure prevents further decline

Resistance: Price level where selling pressure prevents further advance

Role reversal: Broken support becomes resistance; broken resistance becomes support

📊 Why Support/Resistance Works

Psychology: Traders remember past price levels. At $50 support, buyers think "it bounced here before, I'll buy again." Self-fulfilling prophecy creates actual support.

Trend Identification

Uptrend

Series of higher highs and higher lows. Draw trendline connecting lows.

Trading rule: Buy pullbacks to trendline support

Downtrend

Series of lower highs and lower lows. Draw trendline connecting highs.

Trading rule: Sell rallies to trendline resistance (or stay out)

Sideways/Range

Price oscillates between support and resistance.

Trading rule: Buy support, sell resistance, or wait for breakout

Volume Analysis

Volume confirms price moves. High volume validates trends and breakouts.

  • Price up + volume up: Strong bullish signal
  • Price up + volume down: Weak move, potential reversal
  • Breakout + high volume: Likely to continue
  • Breakout + low volume: Likely false breakout

Moving Averages

Simple Moving Average (SMA)

Average price over N periods (e.g., 50-day SMA = average of last 50 days)

Exponential Moving Average (EMA)

Weights recent prices more heavily. More responsive than SMA.

Common Uses

  • Trend identification: Price above 200-day MA = uptrend
  • Support/resistance: MA often acts as dynamic support in uptrends
  • Crossovers: 50-day crossing above 200-day = "golden cross" (bullish)

⚠️ Lagging Indicators

Moving averages are lagging—they tell you where price has been, not where it's going. By the time a crossover signals a trend, significant move may already have occurred.

Basic Chart Patterns

Head and Shoulders (Reversal)

Left shoulder, higher head, right shoulder. Breaks neckline = reversal signal

Double Top/Bottom (Reversal)

Price tests resistance/support twice and fails. Third attempt breaks opposite direction.

Triangles (Continuation)

Converging trendlines. Breakout typically continues prior trend direction.

Flags and Pennants (Continuation)

Brief consolidation during strong trends. Breakout resumes trend.

Timeframes

Multiple timeframe analysis: Check multiple timeframes to confirm signals

  • Long-term (daily/weekly): Overall trend direction
  • Medium-term (4-hour): Entry timing
  • Short-term (1-hour): Precise entry/exit

The Academic Critique

Efficient Market Hypothesis: Past prices don't predict future prices (random walk)

Studies: Most academic research finds technical analysis doesn't beat buy-and-hold after costs

Practitioner response: Works for some traders in specific markets; self-fulfilling prophecies create validity

Limitations

  • Subjectivity: Traders see different patterns in same chart
  • Hindsight bias: Patterns obvious in hindsight, unclear in real-time
  • False signals: Many patterns fail; requires risk management
  • No fundamental basis: Ignores company value, earnings, economic conditions

💡 Practical Approach

Use technical analysis for timing (when to buy/sell), not selection (what to buy). Combine with fundamental analysis: Buy good companies when technicals align.

Key Takeaways

  • Technical analysis studies price charts to predict future movements based on patterns
  • Support and resistance are price levels where supply/demand create barriers
  • Trends (uptrend, downtrend, sideways) persist until clear reversal signals
  • Volume confirms price moves—high volume validates breakouts and trends
  • Moving averages identify trends but lag; crossovers signal trend changes
  • Chart patterns (head/shoulders, double tops, triangles) suggest future direction
  • Academic research questions technical analysis effectiveness; practitioner results vary widely
  • Combine technical analysis with fundamentals for best results—use technicals for timing, not selection