There are plenty of ways to analyze whether an investment is good or not, or when you should buy or sell it. The overall market, economic data, financial statements and fundamentals can all be beneficial factors to examine when looking at a new investment -- whether a stock or another kind of security.

But one of the major ways analysts and investors determine good investments is by using technical analysis

Unlike its counterpart fundamental analysis, technical analysis examines things like trends and price movement to analyze the viability of a potential investment. But what actually is technical analysis and what are some examples? 

What Is Technical Analysis? 

Technical analysis is a process used to examine and predict the future prices of securities by looking at things like price movement, charts, trends, trading volume and other factors. Unlike fundamental analysis, technical analysis focuses on trading signals to delineate good investments and trading opportunities by examining an investment's trends through its trading data and other statistical elements.

As a general rule, technical analysis prizes the current or past price of a security as the best indicator of the future price of that security. Technical analysis relies heavily on financial charts, data and statistics to uncover an investment's strengths or possible weaknesses and forecast trends in order to help analysts and investors decide if a security is viable or not, and for what action. 

How is technical analysis different than fundamental analysis, and do they overlap? 

Technical Analysis vs. Fundamental Analysis

Unlike technical analysis, fundamental analysis focuses on a security's intrinsic value based on things like the company's financial statements, the overall economy and market conditions and other factors like liabilities and assets. While technical analysis focuses on a security's price movements and volume, fundamental analysis looks at how viable the company is on a fundamental level. 

Fundamental analysis is often both qualitative and quantitative in that it examines both numbers and larger factors that might affect the investment's value, like interest rates, competition and the overall economy. And unlike technical analysis, which focuses mainly on the price trends of a security, fundamental analysis seeks to determine the fair market value of that security and where it should be trading. 

Still, proponents of technical analysis argue that many of these factors actually impact or comprise the price of the security and therefore make examining price trends and movements more important. But how does technical analysis function

Technical Analysis Assumptions

Technical analysis is based on several underlying assumptions that it uses to examine stocks and securities:

History Repeats Itself

One of the major tenets of technical analysis is the assumption that history repeats itself, especially with regard to security prices. Technical analysts maintain that prices move in a cyclical nature over time, especially when considering market behavior and human emotions. Looking at things like alternating bull markets and bear markets, the "history-repeating-itself" hypothesis makes sense in a broader sense of market psychology. 

Because of this assumption, technical analysis frequently looks at chart patterns to track how the market acts over time and how prices change, using that as a potential predictor for future price movements. 

Price and the Market Discounts Everything

Another major assumption that technical analysts base their work on is that because price supposedly takes financials, the economy and the overall market into account inherently, examining these factors separately is unnecessary.

In other words, technical analysts consider fundamental analysis largely unnecessary due to the fact that many of the things that fundamental analysts examine about a security or company are already factored in to the price of that security, thereby making technical analysis more important. 

Prices Are Trend-Driven

Lastly, one of the biggest assumptions technical analysis makes is that prices follow trends and aren't random. 

Much of technical analysis involves examining data and chart patterns of historical prices as well as current ones, as technical analysts believe those prices move in trends of different lengths like short term, medium term and long term. 

What are some of the basics of technical analysis? And better still, what are some examples of how to do it? 

Technical Analysis Basics

Given that technical analysis focuses on price, movement, volume and trends, there are several basic aspects and charts that technical analysts look at rather than things like financial statements, which fundamental analysts look at.

What are some of the basics of technical analysis and how are they used to analyze stocks? 

Price

One of the biggest factors technical analysts examine is the price of the security. In fact, price action is the primary measure considered when conducting technical analysis. 

Technical analysts start by examining charts that show a security's price and trading volume to note its historical performance and help predict future movements.  The basic function of using charts to examine stocks or other securities is to identify trends in the investment's price or trading volume and how those trends change over time. 

Technical analysis views investor attitudes and behavior (i.e., the market's psychological aspects) as the biggest movers of securities prices over time. And given the often-cyclical nature of trading patterns, they're also key indicators of how prices will move and change in the future. 

Chart Patterns and Analysis 

As the bread and butter of technical analysis, chart patterns are one of the main ways analysts examine and predict where a stock or security will trade down the road.

One of the most important parts of charts for technical analysis is a so-called "trend line," which shows a security's overall price trend. Additionally, things like "peak/trough analysis" and "moving averages" can help investors or analysts get a better prediction of what stocks are going to do.

While charts look very mathematical, they're really based on plotting and giving a visual representation to investor emotion and market psychology, depicting moves in prices over time. 

There are several types of charts that technical analysts examine, including candlestick charts, line charts, bar charts and more:

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Volume

Another major factor used in technical analysis is volume. Volume is simply the number of shares or contracts that trade for a certain security over a certain period of time, which is generally one day. 

For technical analysis, looking at the volume of a stock or security can help analysts determine the strength of a price movement or trend by showing the amount of shares being traded in that direction (up or down). Volume is expressed as a bar chart at the bottom of a financial chart below the price line (the red and green bars in the charts above). The higher the bar, the higher the trading volume. 

In addition to helping confirm or show the strength of trends and price movements, volume can help confirm chart patterns like so-called "triangle" or "head-and-shoulders" patterns (two types of technical patterns that measure a security's trading or price trends). 

Trend

For a technical analyst, trend is perhaps one of the most important indicators of a stock or security's future performance. Technical analysis prizes examining historical trends to forecast what a stock's price might do in the future. For this reason, human behavior and emotions play a surprisingly key role in technical analysis, as patterns of trading and price movements from the past often indicate how the stock or security might behave in the future. 

There are many different trends, some with strange names like "triangles" and "head and shoulders." (Some other patterns include "rectangles," "cup and handle," "flags and pennants," "candlesticks" and more.)

The three main types of trends are "uptrends," "downtrends" and "horizontal" trends. Uptrends are characterized by higher lows and higher highs, while downtrends are characterized by lower lows and lower highs. (Horizontal trends involve highs and lows that are essentially unchanged.)

And while you could get into the weeds examining each different trend, in general, trends represent the overall direction of a stock's price, which might include its highs and lows. 

In addition, trends have various lengths that analysts use to interpret data -- most commonly "short term," "intermediate term" and "long term." Stocks can experience different trends in the short term (like a brief decrease in price) while still experiencing growth in the long term, so it's important to understand the time frame when analyzing trends. 

Momentum

Momentum measures the speed of the price changes or movements of a particular stock or security. Often coupled with the so-called "relative strength index" (RSI), momentum tracks and measures the rate of price increases or decreases over a set period of time. For example, you could examine the momentum of the price changes for a stock like Disney (DIS) - Get Report for a 10-day period to see the rate of the rise and fall. 

The RSI assigns stocks a value of between 0 and 100 and tracks whether the market is overbought or oversold for a stock. It's generally examined on a daily basis. 

Support and Resistance

When looking at charts and price movements of a stock or security, technical analysts will also examine the stock's "support" and "resistance" levels. Those are the security's previous lows (support) and highs (resistance) that are above or below the stock's current price. These can help indicate if a stock is on a bullish or bearish trend.

Support represents a price where demand for a stock is high enough to typically prevent the price from dipping below that line. Conversely, resistance represents the point where sellers of the stock will come in a dump their shares, keeping the security from moving above a higher price. 

If a stock's price dips below its recent support line, that's bad news that could indicate a bearish trend for the security. But if a stock breaks above its recent resistance line, that typically means that the name is experiencing a bullish trend. In essence, support is the floor price of the stock supporting it to stay higher, while resistance is the ceiling that's keeping the stock's price from going higher:

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Once a stock breaks through its resistance line, that line becomes the security's new support line. Examining where a stock's price currently sits between the support and resistance lines is a major tool that technical analysts use to determine price trends. Because stock prices tend to bounce between support and resistance lines, both are crucial to predicting when a price might move or not (and in which direction).

Support and resistance levels are extremely important in identifying trends and when they might reverse. That's why they're one of technical analysis' key concepts.

Moving Averages

When looking at a daily stock chart, the jagged lines going up and down can sometimes look messy or confusing. That's why examining so-called "moving averages" -- the average of a stock's past price movements -- can help show trends more clearly. These focus on a security's average price movements instead of its day-to-day changes.

There are two types of moving averages -- "simple moving averages" (SMAs) and "exponential moving averages" (EMAs). A simple moving average takes the sum of all the closing prices of a given time period and divides them by the number of prices used. For example, you calculate a 30-day SMA by adding up a stock's closing price over the past 30 market days and dividing that 30.

EMAs use a far more complex formula that weighs more-recent prices slightly more than older ones.

Indicators and Oscillators 

Apart from just resistance or support levels, technical analysts also examine some key indicators like "money flow," "volatility," "momentum" and more to get a mathematical view of the stock or other security.

Indicators are calculations based on statistics like price and volume that help confirm chart patterns and other trends. They're designed to create buy or sell "signals" that help traders or analysts determine where to best enter or exit a trade (and therefore make the most money). By examining these indicators, analysts are able to better confirm a stock's price movements, and therefore the validity of specific chart patterns that experts think they're seeing.

There are plenty of indicators that technical analysts use. Some of the main ones include the "Moving Average Convergence/Divergence" (or "MACD"), the "Aroon indicator" or "Fibonacci retracements."

Indicators can be "lagging" or "leading," meaning that they're either using past data to help describe what's happening to a stock's price or that they're predicting future price action. 

Some of these indicators are also "oscillators," or tools that functions by showing short-term overbought or oversold conditions of stocks. Oscillators are typically bound in a certain range (or between set levels or lines). 

Types of Technical Analysis

In general, there are two main approaches to examining stocks:

'Top-Down' Approach

When analysts are looking at stocks through a top-down approach, they generally analyze securities from a broader to more-specific viewpoint -- often going from looking at a major index like the S&P 500 to sector charts to specific weekly or hourly charts for certain stocks. Technical analysts continue to examine more and more specific charts to determine which stock looks like a good investment. 

When using the top-down approach, technical analysts examine a stock or security's moving averages in a more general-to-specific time frame, such as starting by looking at daily averages and then moving to examining hourly averages for a given stock's price movements. 

For example, a trader might start by looking at how a security is doing on a daily chart. If it's performing bullishly on a daily basis, the trader might then look at its hourly chart to find an optimum point of entry for the stock. 

'Bottom-Up' Approach 

By contrast, a bottom-up approach to technical analysis includes looking for potentially undervalued stocks and examining them on a more fundamental basis to find a point of entry where the stock looks like it's bottomed out.

Technical analysts use the bottom-up approach to look at stocks that are disregarding the overall market's trend, then look for entry or exit points that would put them in the best position to make money on a given name. 

Technical Analysis Example and Steps

So, how do you actually conduct a technical analysis?

One thing to note is that technical analysis can vary from simple (like merely reading a line chart) to very complex (by using add-ons like MACD, candlestick charts, volume and more).  

When conducting technical analysis for yourself, the first thing to do is to pick a stock or security to examine. For example, an investor or analyst could use technical analysis on a stock like Apple (AAPL) - Get Report to decide if it is a buy or not in 2019.

You start by pulling up a chart of Apple's price movements and set a time frame -- either five days, one month or longer (like three months or one year). Here's an example of AAPL's six-month chart:

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The standard chart above shows Apple's price (the black pattern above) and trading volume (the red and green bars).

From that base, you can add additional filters, indicators and other overlays. For example, adding the Aroon overlay (which shows periods of highs and lows on two lines) along with Bollinger bands (which track volatility) can help you interpret where the stock's price might go based on its recent (or long-term) performance.

While there are plenty of ways to conduct technical analysis and a wide selection of overlays and indicators to add to your chart, some questions you can ask yourself when analyzing a chart are:

  • Is the stock trending upwards toward the resistance line, indicating a possible selling or shorting opportunity?
  • Is the stock trending down toward the support line, signaling a potential buying opportunity?
  • What is the stock's short-term trend -- upward, downward or sideways?
  • How has the stock's price performed over the long term? Is Apple experiencing an overall upward trend? 

While there are certainly an exhaustive list of questions and aspects to take into consideration when conducting technical analysis, getting yourself acquainted with the many tools and charts involved can be beneficial to becoming a more educated investor.