Tuesday, February 7, 2012

What is Technical Analysis and Why Should I Care?

Charts are tools you can use to help you invest.

Charts are everywhere. We use them to keep tabs on how our children are growing, how we group ourselves demographically and what the weather is going to be for the next five days. Whenever we show how something changes over time or how it breaks down into its component parts, we are using charts. In the investment world, we usually chart price movements over time. Technical analysis starts with this basic chart and works up from there.

A picture is worth a thousand words

Technical analysis is based on the premise that in order to know where prices are going, we must know where prices have been. In the early days of stock trading, the only way to know where prices have been was to read the ticker tape. Only a very few had access to the tape.

Since most of us are not working on the floor of the exchange, we are blessed with the computers to read the tape for us and send the prices to our home screens and newspapers. However, even getting an idea of the market from these quotes is nearly impossible. The more stocks (or mutual funds, bonds, and futures) we try to follow, the more impossible it is to do our investment research. We can keep track of only so much information in our heads.

Enter the chart. By plotting the closing prices of stocks or other instruments on paper (or a computer screen) each day we can see at a glance not only what the price of the stock is but how it got there. Sure, MicroGiant is trading at 65 up 1/2 but was it 60 last week or 70? Charts put all the data in one place so that a visual animal such as a human being can quickly assimilate them.

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