The Goals and Tenets of Technical Analysis

Two ways to size up a stock

There is more than one way to decide whether a stock is worth buying, and the two most common ones barely talk to each other.

Put crudely: a fundamental analyst reads the label on the jar. A technician watches which jars keep leaving the shelf. Neither is checking the other's work.

What technicians are actually trying to do

Technicians are looking for stocks that are already moving, and they want to buy the ones moving up. That sounds almost too simple to be a discipline, and the simplicity is the point — the appeal of technical analysis is that it gives you specific instructions. Buy here. Sell there. Get out at this price. Whatever else you think of it, it tells you what to do, and it tells you before you're in the trade and emotional about it.

That's why people use it, and why they use it in very different amounts. Some run their entire process on charts. Some pick a company on fundamentals and then use a chart only to decide what day to buy. Some hold for an afternoon; some hold for years. The method scales down to a single decision, which is unusual and useful.

Over this course you'll build a technically based trading plan of your own: reading charts and trends, identifying what belongs on a watch list, finding entry and exit signals, sizing a position so a bad trade can't wreck you, and — the part most people skip — testing whether your rules actually work. We'll mostly use stocks, though the same tools get pointed at other markets.

The three tenets, and what they are

Technical analysis rests on three claims: price moves in trends, the market discounts everything, and history repeats itself. These are usually called the tenets, and the word is doing something important. They are not laws anybody has proven. They are the assumptions the method needs in order to work, stated up front so you can see what you're agreeing to.

That's not a knock on the discipline. Every method has premises — fundamental analysis needs to assume that price eventually catches up to value, which is also unproven and also sometimes fails. But you're entitled to weigh a premise instead of swallowing it, so let's take them one at a time and be honest about how much each one holds.

Price moves in trends

Video coming soon

This lesson explains the idea in full without it.

A trend is the general direction a price is heading: up, down, or sideways. Look at a chart cold and it's noise. Mark the first price, mark the last, draw a line between them, and a direction appears. That direction is the trend.

The first rule technicians teach each other is to trade with the trend, not against it. If you're trying to get to New York, you don't board a train pointed at California and hope. Almost everything in the rest of this course is either a way to identify a trend or a way to act on one, so we'll come back to this constantly.

The market discounts everything

This one says the price already reflects what the market collectively knows. Every trade is somebody putting money behind an opinion, and the price is where all those opinions currently balance. A stock grinding higher is a crowd deciding, dollar by dollar, that it's worth more than it was. A stock falling is the same crowd deciding the opposite.

If that's true, it has a consequence a technician takes seriously: you don't need to know why. The reason is already in the price. When news arrives, the market absorbs it and the price adjusts.

The caveat here is bigger than it first looks, and the tenet itself admits it. Absorbing new information can take longer than anyone expects, and when it finishes it may flip the trend entirely. So "the price knows everything" and "the price is about to be very wrong" are both allowed to be true at once. Hold this tenet loosely.

History repeats itself

Third: patterns that showed up before tend to show up again. Not identically — similarly.

The reasoning is about people, not about prices. A chart is a picture of human behavior, and humans behave in recognizable ways under recognizable pressure. When the economy is running hot, greed drags markets into fast upswings. When it turns, fear drags them down just as fast. The shapes recur because the emotions recur.

Figure

Technicians disagree with each other, too

Everyone in this field accepts the three tenets, and they still don't agree on what a chart says. The main fault line is how much of the decision a human should make.

At one end are discretionary technicians, who read the chart and judge it themselves. Personal interpretation is the tool. The strength is flexibility — a person notices that this situation is unusual. The weakness is that three good technicians can look at one chart and see three different stories, which is exactly as maddening as it sounds.

At the other end are non-discretionary technicians, who try to remove judgment entirely. They rely on indicators — calculations run on price and volume data that produce a buy or sell signal from a formula. Once the rules are formulas, a computer can run them, and some do: quantitative analysts trade with algorithms and statistical models, and high-frequency traders fire off enormous numbers of orders a day. The strength is consistency — a formula doesn't get scared. The weakness is that a formula also doesn't notice that today is different.

Most technicians live somewhere in the middle. The tradeoff is real and there's no correct answer to hand you: judgment adapts and drifts, rules hold firm and stay wrong. And the boundary with fundamental analysis is softer than either camp pretends — plenty of investors value a business first and time the purchase with a chart, or the reverse.

You'll find your own position on that scale. What this course asks is that you find it deliberately, knowing what you gain and what you give up — which is the same thing the rest of it will ask about every rule you write.

Key takeaways

• Technical analysis studies price and volume history to judge probable future movement. Fundamental analysis values the business instead. They ask different questions and neither one checks the other's answer.
• People use technical analysis because it's prescriptive — it produces specific instructions about when to buy and sell, decided before you're in the trade.
• Its three tenets — price moves in trends, the market discounts everything, history repeats itself — are assumptions the method rests on, not proven facts. You're entitled to weigh them.
• "History repeats" means patterns recur because human reactions recur. It does not mean past results predict future ones. Technicians make educated guesses and are regularly wrong.
• Technicians split over how much a human should decide: discretionary reading adapts but drifts, formula-driven rules stay consistent but stay wrong when conditions change. Most people sit between the two.

• Technical analysis studies what a price has already done to guess what it will probably do next. Fundamental analysis studies the business instead. They ask different questions, and neither one checks the other's answer.
• People use it because it gives specific instructions — buy here, get out there — decided ahead of time, before there's any money on the line to make you nervous.
• It rests on three claims: prices move in trends, the price already reflects what everyone knows, and patterns show up again. Those are assumptions the method needs, not things anybody proved. You're allowed to weigh them.
• "Patterns show up again" means people react in familiar ways, not that the past tells you the future. These are educated guesses, and they come out wrong regularly.
• Technicians disagree about how much a person should decide. Reading a chart yourself adapts to what's unusual but drifts over time. Following a formula stays consistent but stays wrong when things change. Most people sit somewhere between.