I’m sure many of us have been in the situation of having to explain what Technical Analysis is to someone who asks. Usually it’s because they noticed the CMT designation after your name and wondered what it means. Or perhaps you found yourself in a heated debate with another financial professional about the merits of a valuation estimate and you brought technical analysis into the discussion.
Not so easy, is it? I’ll bet you stumbled a bit, trying to explain this investment philosophy that is so near and dear to your heart, but something you’ve never actually tried to write down yourself, from memory.
I think it’s worthwhile for practitioners of technical analysis to develop their own definition that they can recite when the opportunity arises. That way you deliver a clear, concise, and accurate message without having to wing it and end up thinking later that you could have done a better job.
Of course, you don’t have to start from scratch. Here are some of the best definitions I could find as a starting point for your own definition.
The CMT Association Constitution defines Technical Analysis in Article 2:
“Technical analysis is the study of data generated by the action of markets and by the behavior and psychology of market participants and observers. Such study is usually applied to estimating the probabilities for the future course of prices for a market, investment or speculation by interpreting the data in the context of precedent.”
The very first definition of technical analysis I ever read was by John Murphy on page 1 of Technical Analysis of the Financial Markets.
“Technical Analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends.”
The last (most recent) definition I’ve read is by Stan Weinstein in Secrets for Profiting in Bull and Bear Markets (page 4).
“All that technical analysis really consists of is the study of price and volume relationships to gain an insight into future trends.”
Aswath Damodaran wrote a whole chapter about technical analysis is his book, Investment Philosophies (pages 209-257), but does not explicitly define technical analysis. He does however quote Edwards & Magee a few times, so let’s look at their definition.
Robert Edwards and John Magee wrote Technical Analysis of Stock Trends in 1948, and on page 5 said this:
“Technical Analysis is the science of recording, usually in graphic form, the actual history of trading (price changes, volume of transactions, etc.) in a certain stock or in ‘the averages’ and then deducing from that pictured history the probable future trend.”
One of the Edwards and Magee quotes in Damodaran’s Investment Philosophies seems perfectly suited to follow their own definition (page 240):
“The market price reflects not only the differing fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, but it also reflects their needs and resources—in total, factors which defy analysis and for which no statistics are obtainable. These are nevertheless all synthesized, weighted and finally expressed in the one precise figure at which a buyer and seller get together and make a deal. The resulting price is the only figure that counts.”
It seems like we should include in our definition some reference to our stance on the Efficient Market Hypothesis. After all, we are making an assumption that price includes all relevant information.
Kirkpatrick and Dahlquist dedicate the first chapter of their book, Technical Analysis, to defining technical analysis, but sum it up on page 1 with the following:
“…technical analysis is the study of prices in freely traded markets with the intent of making profitable trading or investment decisions.”
But they also list five assumptions of technical analysis that were presented in Edwards and Magee to clarify what it is, and they go on to say that “the technical analyst believes that all [relevant] factors are already factored into the demand and supply curves and, thus, the price of the company’s stock.”
So they include the idea that technical analysis takes a specific stand in the debate about market efficiency.
On page 3 of Technical Analysis Explained, Martin Pring defines it as:
“the art of identifying trend changes at an early stage and to maintain an investment or trading posture until the weight of the evidence indicates that the trend has reversed.”
Pring defines “evidence” as a series of scientifically derived indicators or techniques that work well most of the time in the trend-identification process (page 9). He also expounds on what he means by “art”, saying that it consists of combining indicators into an overall picture and recognizing when that picture resembles a market peak or trough.
In case you were unaware, technical analysis is actually covered in the CFA Program Level 1 curriculum, written by Aksel Kibar, CMT; Barry M. Sine; and Robert A. Strong, PhD, CFA. Here’s the CFA definition:
“Technical analysis is a form of security analysis that uses price and volume data, often graphically displayed, in decision making. Technical analysis can be applied to securities in any freely traded market around the globe. A freely traded market is one in which willing buyers trade with willing sellers without external intervention or impediment. Prices are the result of the interaction of supply and demand in realtime. Technical analysis allows us to see a battle between buyers and sellers, along with subtle clues as to which side may be winning. Technical analysis is used on a wide range of financial instruments, including equities, bonds, commodity futures, currency futures, and cryptocurrencies.”
Finally, just for fun, I tried out ChatGPT, the artificial intelligence driven chatbot that has captivated the news lately, and told it to “explain what technical analysis is”. For what its worth, here you go.
“Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. The idea behind technical analysis is that market trends, as shown by charts and other technical indicators, can predict future activity.
Technical analysts believe that the study of past market data, primarily price and volume, can provide insight into future market activity. They use charts and other technical tools to identify trends and make trading decisions. For example, a technical analyst might look for patterns in a stock’s price chart that suggest a buying or selling opportunity, or use a technical indicator such as moving average to identify a trend.
It’s important to note that technical analysis is a controversial approach to security analysis, and not all investors and traders believe in its effectiveness. While some view it as a valuable tool for making informed investment decisions, others believe it to be unreliable and based on subjective interpretation of market data.”
Realistically, everyone should develop their own definition that will be most effective in whatever professional setting you are in most often, whether it is a layperson or another investment professional. Being consistent with your message will seriously improve how people evaluate your use of technical analysis as a valuable tool for securities analysis.