What is technical analysis?
Learning objectives
Explain what technical analysis is and the three assumptions it rests on
Distinguish technical from fundamental analysis and say where each is useful
State honestly what technical analysis can and cannot do for a trader
A quick caveat...
Technical analysis is the study of price itself. Not the company behind the share, not the economy behind the currency, just what price has actually done and where participants have reacted before.
It's important to remember that technical analysis itself is never a perfect predictor. What technical analysis is good for becomes much clearer once you stop expecting it to be a crystal ball.
Three assumptions
Technical analysis rests on three ideas, inherited largely from Dow Theory over a century ago.
- Price reflects everything currently known. Every participant's information, opinion and expectation is already expressed in the price, so studying price studies all of it at once.
- Price moves in trends. Movement is more likely to continue in its current direction than to reverse at random.
- Behaviour repeats. Participants respond to similar situations in similar ways, so patterns recur.
Now the part that most introductions leave out: these are assumptions, not laws.
The first is a version of the efficient market hypothesis, and it's genuinely contested among economists. The second holds in some conditions and clearly fails in others, which is why ranging markets destroy trend-following approaches. The third is a claim about human psychology, and it's the sturdiest of the three, but it produces tendencies rather than rules.
A framework built on contested assumptions can still be useful. It just can't be treated as physics.
Technical and fundamental analysis
While both are important parts of analysis, they ask different questions.
Fundamental analysis asks why something should be worth more or less. Interest rate expectations, inflation data, company earnings, supply and demand in the physical world. Our lesson on markets covered what drives each asset class, and that was fundamental thinking.
Technical analysis asks what price is actually doing and where participants have previously reacted.
These aren't rivals, and treating them as opposing camps is a hobby rather than a strategy. Most traders use both: fundamentals for context and direction, technicals for levels and timing. A view that the dollar will weaken is fundamental. Deciding to act on it at 1.0850 with a stop at 1.0825 is technical.
What technical analysis can (and can't) do
Here's the part you deserve to be told plainly.
Academic evidence for technical analysis as a predictive tool is mixed at best, and largely unsupportive for simple rules-based systems tested over long periods. Any material claiming that technical analysis predicts price is overselling something. Be suspicious of it, and be especially suspicious when it's attached to something for sale.
What technical analysis does provide, reliably:
A consistent decision framework. This is worth more than it sounds. Inconsistency is what ruins most retail traders, not a lack of predictive power. A trader making decisions the same way every time can evaluate their method. A trader improvising cannot.
Defined levels. Stop losses need an invalidation level and take profit orders need a plausible target. Technical analysis is where both come from. Without it you have a risk framework with nowhere to put the numbers.
A shared vocabulary. Many participants watch the same levels and the same moving averages. That's part of why those levels matter at all, and it's reflexive rather than magical. Enough orders clustered around 1.0900 makes 1.0900 a place where something tends to happen. It does not make 1.0900 a wall.
What it can't do
- Predict news. A central bank surprise or a geopolitical event overrides every chart on the screen.
- Provide certainty. Every level, pattern and signal is probabilistic, and the probabilities are less favourable than they look in hindsight.
- Work without risk management. A perfect read of the chart, sized wrongly and without a stop, still empties an account. Our 'Why beginners lose money' lesson covers why.
- Be validated by a small sample. Any approach will produce runs of correct calls by chance. Review our lesson on drawdown for the numbers that explain this.
So why learn it?
Because of the second point in that earlier list, and it's enough on its own.
Your risk rules from the earlier course require inputs. Stop loss orders need a price at which your reason for the trade is no longer true. Take profit orders need a target the market plausibly reaches. Lesson F2.3 needs the distance between your entry and your stop.
Technical analysis is how you produce those three numbers in a consistent, repeatable way. That's a modest claim, and unlike the grander ones, it's defensible.
Its job in this academy is to feed your risk framework, not to tell you the future.
What to learn, and in what order
Three things, and no more until those three are genuinely comfortable:
- Reading price directly. Candlesticks and what they tell you about the balance between buyers and sellers. That's lesson F4.2.
- Structure. The levels and trends that price has actually respected.
- A very small number of indicators, properly understood. Lesson F4.4 covers two.
And one warning that will save you months. The standard failure mode is adding indicators. Six on a chart feels like six opinions confirming each other. It isn't. Every one of them is calculated from the same price data, so what you have is one opinion, stated six times, with the confidence that comes from mistaking repetition for agreement.
Key takeaways
Technical analysis studies price itself, resting on three assumptions that are contested rather than proven
Technical analysis asks a different question from fundamental, and most traders use both: fundamentals for context, technicals for levels and timing
Evidence for it as a predictive tool is weak. Its real value is consistency and the defined levels for your risk rules
Adding more indicators doesn't add more information, because they're all derived from the same price data