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Technical Analysis – Defined

[By Julia O’Neal; MA, CPA with Staff writers]

Technical market analysis focuses on the historical price and volume changes that occur as a stock trades, and it attempts to predict the stock’s future behavior based on prior patterns.

Technical analysis is not concerned with the financials of a company; it assumes that fundamental factors are already reflected in the market behavior of a stock and that the history of that behavior gives a strong clue to the future. The focus on price and volume in technical analysis could also be considered a study of supply and demand. 

Technical analysis applies technical market theories to stock market data on stock prices, indexes, and trading. Technicians identify market trends and try to predict future movements.  

Theoretically, technical and fundamental analysis exist in opposition to each other, but in reality, most fundamental analysts sneak a look at the charts from time to time and technical analysts pay attention to some fundamentals. 

Both schools of thought are based on the possibility of predicting the future using the past. Market psychology, which does not always follow rhyme or reason, can prove both types of analysis wrong.

Technical analysis involves discovering patterns that repeat themselves. Patterns can exist for an individual stock or for an index, and stocks can be compared to their respective indexes. 

Stocks (and indexes) are said to trade in a range. When prices go above this range, they often encounter selling pressure. This is called an area of resistance, and stocks are characterized as “overbought.” 

Conversely, a decline below a level of support will instigate buying, because the stock seems cheap or “oversold.” 

When a breakout occurs above a resistance level – or below a support level – technical analysts predict the stock will stay on the new course.  

Methods for taking advantage of anticipated upward trends include buying stop orders or call options at a level slightly above the resistance level.  To profit from downward trends, physician investors would enter a sell-stop order, sell short, or purchase put options at a price slightly below the support level.  

• Accumulation areas occur when medical buyers are accumulating stock and the support level is moving up.  
• Distribution areas occur when physician selling is occurring and the stock is considered weak.  
• A sideways movement (the stock continues to be bought and sold at the same price for some time) is called an area of consolidation. 

Other technical patterns:

A head and shoulders pattern may be either above (“head and shoulders top”) or below (“head and shoulders bottom”) a constant trend line. This theory assumes that after a top there will be a reverse; after a bottom, there will be a move back to a top.  

Rising bottoms and ascending tops/falling bottoms and descending tops.  A rising trend in the low prices of a security shows higher and higher support levels. Combined with ascending tops, this would be a bullish indicator. The reverse would be bearish. 

Double top and double bottom show resistance and support levels.  A double bottom shows the stock could break below support levels and reach new lows; a stock with a double top pattern might be expected to move on to a new high.

Assessment

What kind of physician investor are you; fundamental or technical?

Conclusion

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