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Technical Analysis

February 19th, 2009 by Neal Walters

by Walter Fox

Technical Analysis is a technique for forecasting the direction of stock prices based on past market data. Itas simplest form takes only two variables into account: 1) price, and 2) volume. At this level, Technical Analysis is an overly simplified statistical analysis of market trends, and while many people have claimed positive results, it does not stand up to the scrutiny of academic mathematicians.

Fundamental analysis, in contrast, creates a comprehensive company profile to determine future trend patterns. Historically, technical analysts have claimed that any relevant company specific data would affect stock price or volume, and would therefore be included in the technical analysis.

The purpose of Technical Analysis is to take the guesswork out of investing. It seeks to increase profits by predicting the future of the markets and trading against those predictions. Fundamental Analysis does the same thing but prefers to use different data, or use data differently. Perhaps more than Fundamental Analysis, Technical Analysis seeks to automate the decision making process by producing a purely quantitative measure of future trends.

One of the typical graph patterns used by professional technical analysts to make trading decisions is the, aHead and Shoulders.a Two similar-sized peaks with a higher center peak are graphic indicators. These patterns may not be mathematically valid, argue some critics, but the result of the psychological predisposition of humans to form patterns in a random geographical area.

While Technical Analysis seeks to use a purely quantitative measure for predicting market trends, it is limited by a number of factors: Technical analysts traditional ignore a lot of quantitative data. Analysts tend to adhere to particular paradigms, which favor different charting methods and attribute more or less weight to particular statistical patterns as market indicators, which reveals a subjective bias on the part of the Analyst.

Machine learning and artificial intelligence are the new frontier for both technical analysis and fundamental analysis. These computers can make the decision making process of investing automated, without consideration of how much data can be physically processed by an individual.

Machine learning has no predisposition to identifying false patterns, and it is able to include disparate data, which on the surface appears to have no correlation to the trends being analyzed. Furthermore, machine learning will identify patterns at any scale. While Analysts tend to look for large (significant) trends, at the machine level, any scale is significant if a trend can truly be identified.

While it is plausible that many existing analytical paradigms will become obsolete as our tools improve, it is unknown whether machines will replace technical analysis or merely reveal the shortcomings of our prior techniques and help us to improve them.

About the Author:

TheScienceOfTrading.com provides 90 free minutes of videos on stock option investing and provides a complete and detailed option trading course for beginners to experts.

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