Fundamental Notions of Technical Analysis

In its simplest form, technical analysis consists of plotting the stock market performance of securities prices and the use of patterns, indicators, and oscillators in order to predict future evolution. In more complex forms, any process that considers price movements to be decisive (at the expense of the issuer’s financial data) can be considered as belonging to technical analysis. Technical analysis, modern portfolio theory, and valuation by market comparison—all these are based on the informational efficiency of the market (Fama): the price reflects all the necessary information about a company. What can be observed is easy to guess: the price varies according to the struggle between buyers (who want as low a price as possible) and sellers (who want a price as high as possible) even when nothing happens in the company in order to justify the change. Some theories consider the trajectory of stocks to be arbitrary (random walk). Obviously, this would mean that their evolution cannot be predicted, thwarting any predictive effort. While it is true that no accurate predictions can be made, the evolution may not be random: the order of magnitude depends on the financial characteristics of the issuer, the drunkenness walk shows that statistics can be applied even if the movement is disordered (Brownian), when the market trend is strong it is not hard to anticipate that it will attract many issuers, etc. The autoregressive theories AR, ARMA, ARIMA, etc., and ARCH, GARCH, etc., attempt to demonstrate the unpredictability of the stock market evolution—we will review them. Technical analysis provides a very eloquent graphical insight on the evolution of a security. On any stock exchange in the world, if you opened the electronic platform of a company it can be seen the chart of recent evolution. Regardless of the context, an analysis is not complete if it does not present these charts, even if only for information. There is no broker or trader who does not look at the chart before initiating a trade; there is no consultant or analyst who does not present these graphs to a client. Technical analysis alone cannot explain or predict an issuer’s evolution. Try to predict the movement of a security on chartgame.com, even in competition with a professional technical analyst and you will see that the chances of winning are equal. On its own, without market or company information, technical analysis is not a magic mirror that predicts the future based on past performance.