Technical Analysis: Foundations
Technical analysis studies past prices and trading volume to forecast future price moves, in deliberate contrast to fundamental analysis of intrinsic value. It rests on three working assumptions. First, price discounts everything, so all known information is already reflected through supply and demand. Second, prices move in trends that tend to persist until they reverse. Third, history rhymes, because recurring patterns in crowd behaviour show up again on the chart. Analysts read these patterns through price charts, lines of support and resistance, and confirming volume.
Why it matters
A technician treats the chart as a record of every hope, fear, and order that has already cleared the market, so the price itself becomes the headline rather than the earnings report behind it. Support is a price floor where buyers have repeatedly stepped in, and resistance is a ceiling where sellers have repeatedly taken profit. The bet is behavioural. Crowds react to gains and losses in patterned ways, and those patterns leave a trace a careful reader can act on before the move completes.
Formulas
Worked examples
A stock falls toward A$20 four separate times over two months and bounces each time, never closing below it. What is the technician watching, and what would change the read?
The repeated bounces mark A$20 as a support level where demand has reliably absorbed selling. A technician treats a hold above A$20 as the trend staying intact. A decisive close below A$20 on heavy volume would signal that support has broken, often flipping that same level into future resistance on the way back up.
Common mistakes
- ✗Technical analysis is proven to beat the market. The weak form of the Efficient Market Hypothesis holds that past prices already reflect in current prices, which would strip predictive value from charts. The academic evidence is mixed and contested rather than settled in favour of charts.
- ✗Technical and fundamental analysis are enemies that cannot mix. Many practitioners use fundamentals to choose what to own and technical signals to time entries and exits, treating the two as complementary lenses.
- ✗A support or resistance line is a precise law. These are zones of crowd behaviour, not physical barriers. Prices routinely pierce a level briefly before the real signal, so technicians wait for confirmation such as a clear close and supporting volume.
- ✗Volume is a minor detail next to price. Volume measures conviction behind a move, so a breakout on thin volume is treated as far less reliable than the same move on heavy volume.
Revision bullets
- •Technical analysis forecasts prices from past price and volume, not intrinsic value
- •Three assumptions: price discounts everything, prices trend, history rhymes
- •Supply and demand set price; charts visualise the balance
- •Support is a repeated price floor, resistance a repeated ceiling
- •Volume confirms or weakens a price signal
- •The approach sits in tension with the weak form of the EMH
Quick check
Which assumption is a core foundation of technical analysis?
A stock repeatedly stalls and turns lower near A$50. A technician would most likely label A$50 as
Connected topics
Sources
- Brailsford, Heaney & Bilson (2015), Ch. on technical analysisBrailsford, T., Heaney, R., & Bilson, C. Investments: Concepts and Applications. 5th ed. Cengage Learning Australia, 2015.Sets out the assumptions of technical analysis and the supply and demand reading of price charts.
- Bodie, Kane & Marcus (2021)Bodie, Z., Kane, A., & Marcus, A. J. Investments. 12th ed. McGraw-Hill Education, 2021.Reference treatment of technical analysis alongside the weak-form efficient market evidence.