What technical analysis is, and what it is for
The answer
Technical analysis is the study of price and volume, on a chart, to make a judgement about what is likely to happen next. It ignores the business on purpose, and that is both its whole method and its whole weakness.
Why this costs you money
Here is the mistake, and it is expensive in both directions.
The first version: you buy a company because the business is good, and you have no plan for what a falling price means. The stock drops 20%. You buy more, because the business is still good. It drops another 30%. You buy more. Nothing in your method can ever tell you that you are wrong, because your method only looks at the company, and the company's annual report will not arrive for 9 months.
The second version: you buy because a shape on a chart looked like a shape in a book. You have no idea what the company does. When the price moves against you there is nothing to hold on to, so you either sell at the worst moment or you convert a trade into an investment by inventing a reason to keep it.
Both people are missing the same thing. They have one instrument and they are using it to answer a question it was never built to answer.
Technical analysis answers "when", and it answers it badly on its own. Fundamental analysis answers "what", and it answers it slowly. A trader who does not know which question a tool answers will apply the wrong tool at the worst moment, every time.
How it works
Technical analysis rests on 3 stated assumptions. They are usually presented as facts. They are not facts. They are assumptions, and each one is true sometimes.
1. The price discounts everything.
The claim is that every known fact, opinion, fear and forecast is already contained in the last traded price. The chart is therefore a summary of what every participant believes, weighted by how much money each of them committed.
This is the strongest of the 3. It is also the most misread. It does not say the price is correct. It says the price is the current agreement. An agreement can be the average of a crowd that is wrong together.
2. Price moves in trends.
The claim is that a price that has been rising is more likely to keep rising than to reverse, until something changes. This is the assumption that everything practical in technical analysis depends on. Without it, no entry rule and no exit rule has any basis.
It is the assumption with the most academic support, and the support is narrower than most traders think. The next article covers exactly what is and is not supported.
3. History repeats itself.
The claim is that people react to price in similar ways over time, so shapes on a chart recur. Fear and greed do not change; only the instruments do.
This is the weakest of the 3. It is also the one that sells the most books, because it is the one that turns into a pattern dictionary.
Given those assumptions, the whole method is this. You take a series of prices. You draw it in a way that makes some feature visible. Then you make a conditional judgement: given what price has done, what is the balance of probability about what it does next?
Not a prediction. A conditional probability. Every honest technician talks this way, and every dishonest one talks about targets.
What it tells you, and what it does not
A chart tells you 4 things, and it tells you them precisely.
- Where the price has been.
- How fast it got there.
- How much was traded at each level, which tells you where people have positions.
- Where the price has previously stopped, which tells you where people paid attention before.
That last one is not mystical. If a stock fell hard from 400 twice, there are people who bought near 400 and are still holding a loss. When it returns to 400, some of them sell to get out even. That is a real, mechanical reason a level can matter, and it does not require anybody to believe in charts.
Here is what a chart cannot tell you.
It cannot tell you whether the business is any good. A chart of a fraud looks exactly like a chart of a great company, until the day it does not.
It cannot tell you why the price moved. It can show you that a large seller was present. It cannot show you whether that seller was a hedge fund closing a position, a promoter meeting a margin call, or an index fund rebalancing.
And it cannot tell you the size of what you do not know. Every chart looks complete. The information that has not reached the market yet leaves no mark on it at all.
The decision rule
Use a chart to decide when and how much. Use the business to decide what and whether.
If a chart tells you to buy something you cannot describe in 2 sentences, do not buy it.
If your view of a business tells you to buy and the price has been falling for 8 months, you are not wrong yet — but you must be able to say what price behaviour would tell you that you are.
The second half of that rule is the one that saves money. Fundamental analysis has no natural stopping point. Technical analysis has nothing else. A method that combines them uses each one where it is strong.
Try this now
This tests the first assumption on your own holdings, which is the only way to believe it or disbelieve it honestly. It takes about 5 minutes.
- Pick 3 stocks you own or follow.
- For each, find 1 dated company announcement from the last 12 months. In India, use the Corporate Announcements section on the NSE or BSE website for that company. In the United States, use the company's investor relations page or its 8-K filings on SEC EDGAR. Write down the date and whether the news was good or bad.
- Open the daily chart for that stock. Look at the 10 trading sessions before the announcement date.
- For each stock, write 1 word: yes, if the price clearly moved in the direction the news later justified, by more than its normal weekly range. No, if it did not. Unclear, if you cannot honestly tell.
- Count your 3 answers.
What you should see. A mix. For most readers it comes out as roughly 1 clear yes, 1 clear no, and 1 unclear. That mix is the honest state of "the price discounts everything". Sometimes the market moves before the news is public. Often it does not. And you cannot tell in advance which case you are in.
If you get 3 out of 3 yes, check whether you chose the announcements by looking at the chart first. That is the single most common way people fool themselves in technical analysis, and it is worth catching in yourself now rather than in 5 years.
Three real cases
1. Satyam Computer Services, December 2008 to January 2009 (India) — the price knew something, then knew nothing On 16 December 2008 the company announced it would buy 2 property firms owned by the founder's family. The market reacted violently and the deal was abandoned within hours. The share price fell sharply over the following weeks. Then on 7 January 2009 the chairman, B. Ramalinga Raju, resigned and admitted the company's cash balances had been fabricated for years. The share price fell by roughly 78% that day. Read this case both ways. The chart did react to the governance warning in December, before most retail holders understood it. The chart gave no warning at all about years of fabricated accounts before December. Both statements are true about the same stock.
2. Enron, 2000 to 2001 (United States) — a year-long decline before the disclosure Enron's shares traded around $90 in August 2000. The price declined through 2001, well before the company restated its earnings in October 2001 and filed for Chapter 11 bankruptcy protection on 2 December 2001. A holder using a simple trend rule would have been out during 2001. A holder using only the published accounts had no reason to sell, because the published accounts were false. This is the best argument technical analysis has: when the numbers are lies, the price is the only honest data you have.
3. SVB Financial Group, March 2023 (United States) — the case that does not support the method Silicon Valley Bank's parent traded above $260 in early March 2023. It announced a capital raise and securities losses after the close on 8 March 2023. The shares fell about 60% on 9 March and were halted on 10 March, the day regulators closed the bank. The whole event took roughly 48 hours. On a daily chart there was no useful advance warning. A bank run is faster than any chart method, because a chart needs a sequence and this had none. Include this case every time you are tempted to believe the price always tells you first.
The question that resolves it
A novice looks at a chart and asks: what is this pattern telling me?
An expert asks: who has a position at these prices, and what will they be forced to do?
The second question turns a shape into a mechanism. A level matters because people transacted there and now have gains or losses to manage. A breakout matters because it forces short sellers to buy. When you can name the group of people the pattern is about, the pattern is real. When you cannot, you are looking at a shape.
What would make this wrong
If price contained no information about future price, then every method built on charts would produce results indistinguishable from random entry, in every market and every period. That is a testable claim and the tests exist. The next article covers them properly, and the answer is not a clean yes or no.
The honest limits of this article are 3.
First, "the price discounts everything" is measurably false in specific, identifiable situations. A newly listed company with 3 weeks of history. A stock with almost no daily volume. A company where the material facts are hidden by fraud. In each case the price cannot discount what nobody knows.
Second, technical analysis has a built-in tendency to look better than it is, because charts are read after the fact. The eye finds the correct signal instantly on a completed chart. Nobody photographs the 40 identical setups that failed.
Third, none of these 3 assumptions is a law. They are working beliefs. A method built on working beliefs can be useful and can also stop working, and a good technician holds it that way.
In India
The Indian market gives a chart reader 2 structural features that do not exist in most other markets.
Price bands. Most stocks outside the derivatives segment carry a daily price band of 2%, 5%, 10% or 20%. When a stock reaches its band, trading effectively stops at that price. The candle for that day is truncated by a rule, not by an agreement between buyers and sellers. A chart reader who does not know this will interpret a flat top as resistance. It is not resistance. It is a ceiling imposed by the exchange, and the price will usually keep going in the same direction the next morning.
Circuit breakers on the index. Market-wide halts trigger on the Nifty 50 or the Sensex at moves of 10%, 15% and 20%, with the halt duration depending on the time of day. On such a day the index chart is a record of an interrupted auction.
Two more things matter. Indian companies carry out bonus issues, splits and rights issues far more often than large US companies, so a raw price series will contain large false gaps. Always confirm your charting platform is showing an adjusted series. And delivery volume is published separately from total traded volume by NSE and BSE, which is genuinely useful information that most US markets do not disclose in the same form.
In the United States
The United States gives a chart reader a longer day and a more fragmented one.
The session is longer than the chart usually shows. Regular trading runs from 9:30 to 16:00 Eastern time. Pre-market trading starts at 4:00 and after-hours trading runs to 20:00. Most companies release results outside regular hours. This means the large move often happens when the chart is not drawing, and the daily candle simply opens at a new price.
Volume is spread across many venues. Trades execute on more than a dozen exchanges and a large number of off-exchange venues. The volume bar on your chart is the consolidated tape, or your data provider's version of it, and a meaningful share of volume prints away from public quotes. Volume-based analysis in the US is analysis of a reported aggregate, not of a single order book.
Limit Up-Limit Down replaces fixed daily price bands. A stock that moves too far too fast enters a brief pause rather than stopping for the day. Market-wide circuit breakers on the S&P 500 sit at 7%, 13% and 20%.
Where they differ, and what that tells you
The most useful difference for a chart reader is what a gap means.
In the United States, a gap between yesterday's close and today's open is usually a gap in the chart, not a gap in trading. The stock traded through most of that range in the pre-market session. Somebody transacted at those prices. There is a real order book behind the empty space.
In India, an equity gap is closer to a true absence. Between 15:30 and the next morning's pre-open at 9:00, there is no on-exchange trading in that stock at all. Nobody transacted in the gap. The one large exception is the index itself: Nifty futures trade at GIFT City for roughly 21 hours a day, so for the index there is an overnight market and the "gap" has prices inside it.
What that tells you is practical. A common piece of American chart advice is that gaps get filled, because the prices inside the gap were real prices where real buyers waited. That reasoning is much weaker for an Indian single stock, where the gap is genuinely empty. Copy the rule without the reasoning and you will hold a losing position waiting for a fill that has no mechanism behind it.
The second difference is corporate actions. Because Indian companies act on their share capital more often, an Indian chart depends more heavily on the data provider's adjustment. It is worth knowing whether your platform adjusts for dividends as well as splits, because the 2 series can differ by a great deal over 10 years, and every long-term level you draw sits on that choice.
Carry this
- A chart answers "when" and "how much". It does not answer "what" or "whether".
- The 3 assumptions are assumptions. Each is true sometimes.
- If you cannot name the group of people a pattern is about, it is a shape.
- In India, check that your price series is adjusted. In the US, check what happened before the open.