Is technical analysis based on some underlying factors in the market or do they work simply because other people use them?
Technical analysis is based more on psychology than anything else. As an example, if an analyst estimates or believes that a stock is undervalued, or simply wants to re-balance their portfolio, then they will buy some amount, moving the price up. Others in the market see the upwards move as the start of an upwards trend, an indication that the stock is undervalued or perhaps even that an insider is trading ahead of better than expected data from the firm. They then buy the stock creating a self-fulfilling prophecy and pulling more traders in as they see an upward trend being confirmed. This is even more pronounced in a bear market as fear is an even stronger driver. When a trader sees a stock is falling they are more likely to jump to the conclusion that it is due to expected poor performance of the firm and that the firm and the economy are both in trouble and going down than to think that it is simply a retrenching or a large investor re-balancing etc. To quote Credit Suisse [1]  A chart is a mirror   of the mood of the crowd and not of the fundamental factors. Thus, technical analysis is the   analysis of human mass psychology. Therefore, it is also called behavioral finance. The underlying truth that makes technical analysis work is that people are predictably irrational, at least in the short run and tend to follow the same patterns of thought. references: [1] https://www.credit-suisse.com/pwp/pb/pb_research/technical_tutorial_de.pdf [2] http://www.amazon.com/The-Psychology-Technical-Analysis-Profiting/dp/1557385432 [3] CFA level 1 syllabus Technical Analysis assumes that the only relevant number(s) regarding a security is (are) price (and price momentum, price patterns, price harmonics, price trends, price aberrations, etc.). Technical is all based on price. Technical is not based on any of the fundamentals.  Technical Analysis is for traders (speculators) not for long term investors. A long term investor is more concerned with the dividend payment history and such similar data as he makes his money from the dividend payments not from the changes in price (because he buys and holds, not buy low sell high). "Both explanations are partly true. There are many investors who do not want to sell an asset at a loss.  This causes ""resistance"" at prices where large amounts of the asset were previously traded by such investors.  It also explains why a ""break-through"" of such a ""resistance"" is often associated with a substantial ""move"" in price. There are also many investors who have ""stop-loss"" or ""trailing stop-loss"" ""limit orders"" in effect.  These investors will automatically sell out of a long position (or buy out of a short position) if the price drops (or rises) by a certain percentage (typically 8% - 10%). There are periods of time when money is flowing into an asset or asset class.  This could be due to a large investor trying to quietly purchase the asset in a way that avoids raising the price earlier than necessary.  Or perhaps a large investor is dollar-cost-averaging.  Or perhaps a legal mandate for a category of investors has changed, and they need to rebalance their portfolios.  This rebalancing is likely to take place over time.  Or perhaps there is a fad where many small investors (at various times) decide to increase (or decrease) their stake in an asset class.  Or perhaps (for demographic reasons) the number of investors in a particular situation is increasing, so there are more investors who want to make particular investments.  All of these phenomena can be summarized by the word ""momentum"". Traders who use technical analysis (including most day traders and algorithmic speculators) are aware of these phenomena.  They are therefore more likely to purchase (or sell, or short) an asset shortly after one of their ""buy signals"" or ""sell signals"" is triggered.  This reinforces the phenomena. There are also poorly-understood long-term cycles that affect business fundamentals and/or the politics that constrain business activity.  For example: Note that even if the markets really were a random walk, it would still be profitable (and risk-reducing) to perform dollar-cost-averaging when buying into a position, and also perform averaging when selling out of a position.  But this means that recent investor behavior can be used to predict the near-future behavior of investors, which justifies technical analysis."
"Below is just a little information on this topic from my small unique book ""The small stock trader"":  The most significant non-company-specific factor affecting stock price is the market sentiment, while the most significant company-specific factor is the earning power of the company. Perhaps it would be safe to say that technical analysis is more related to psychology/emotions, while fundamental analysis is more related to reason – that is why it is said that fundamental analysis tells you what to trade and technical analysis tells you when to trade. Thus, many stock traders use technical analysis as a timing tool for their entry and exit points. Technical analysis is more suitable for short-term trading and works best with large caps, for stock prices of large caps are more correlated with the general market, while small caps are more affected by company-specific news and speculation…: Perhaps small stock traders should not waste a lot of time on fundamental analysis; avoid overanalyzing the financial position, market position, and management of the focus companies. It is difficult to make wise trading decisions based only on fundamental analysis (company-specific news accounts for only about 25 percent of stock price fluctuations). There are only a few important figures and ratios to look at, such as: perhaps also: Furthermore, single ratios and figures do not tell much, so it is wise to use a few ratios and figures in combination. You should look at their trends and also compare them with the company’s main competitors and the industry average. Preferably, you want to see trend improvements in these above-mentioned figures and ratios, or at least some stability when the times are tough. Despite all the exotic names found in technical analysis, simply put, it is the study of supply and demand for the stock, in order to predict and follow the trend. Many stock traders claim stock price just represents the current supply and demand for that stock and moves to the greater side of the forces of supply and demand.  If you focus on a few simple small caps, perhaps you should just use the basic principles of technical analysis, such as:  I have no doubt that there are different ways to make money in the stock market. Some may succeed purely on the basis of technical analysis, some purely due to fundamental analysis, and others from a combination of these two like most of the great stock traders have done (Jesse Livermore, Bernard Baruch, Gerald Loeb, Nicolas Darvas, William O’Neil, and Steven Cohen). It is just a matter of finding out what best fits your personality.  I hope the above little information from my small unique book was a little helpful! Mika (author of ""The small stock trader"")" Technical Analysis in general is something to be cognizant of, I don't use a majority of studies and consider them a waste of time.  I also use quantitative analysis more so than technical analysis, and prefer the insight it gives into the market. The markets are more about predicting other people's behavior, psychology. So if you are trading an equity that you know retail traders love, retail traders use technical analysis and you can use their fabled channel reversals and support levels against them, as examples. Technical analysis is an extremely broad subject. So I suggest getting familiar, but if your historical pricing charts are covered in various studies, I would say you are doing it wrong. A more objective criticism of technical analysis is that many of the studies were created in the 1980s or earlier. Edges in the market do not typically last more than a few weeks. On the other side of that realization, some technical analysis works if everyone also thinks it will work, if everyone's charts say buy when the stock reaches the $90 price level and everyone does, the then stock will go higher. But the market makers and the actions of the futures markets and the actions of options traders, can undermine the collective decisions of retail traders using technical analysis. There are all sorts of topics in finance that take a lot of time to learn.  You have valuation (time value of money, capital asset pricing model, dividend discount model, etc.), financial statement analysis (ratio analysis, free cash flow &amp; discounted cash flow, etc.) , capital structure analysis(Modgliani &amp; Miller theories of capital structure, weighted average cost of capital, more CAPM, the likes), and portfolio management (asset allocation, security selection, integrates financial statement analysis + other fields like derivatives, fixed income, forex, and commodity markets) and all sorts.   My opinion of Investopedia is that there is a lot of wheat with the chaff.  I think articles/entries are just user-submitted and there are good gems in Investopedia but a lot of it only covers very basic concepts.  And you often don't know what you don't know, so you might come out with a weak understanding of something.    To begin, you need to understand TVM and why it works.  Time value of money is a critical concept of finance that I feel many people don't truly grasp and just understand you need some 'rate' to use for this formula.  Also, as a prereq, you should understand basics of accrual accounting (debits &amp; credits) and how the accounting system works.  Don't need to know things like asset retirement obligations, or anything fancy, just how accounting works and how things affect certain financial statements.  After that, I'd jump into CAPM and cost of capital.  Cost of capital is also a very misunderstood concept since schools often just give students the 'cost of capital' for math problems when in reality, it's not just an explicit number but more of a 'general feeling' in the environment.  Calculating cost of capital is actually often very tricky (market risk premium) and subjective, sometimes it's not (LIBOR based).    After that, you can build up on those basic concepts and start to do things like dividend discount models (basic theory underlying asset pricing models) and capital asset pricing models, which builds on the idea of cost of capital.    Then go into valuation.  Learn how to price equities, bonds, derivatives, etc.  For example, you have the dividend discount model with typical equities and perpetuities.  Fixed income has things like duration &amp; convexity to measure risk and analyze yield curves.  Derivatives, you have the Black-Scholes model and other 'derivatives' (heh) of that formula for calculating prices of options, futures, CDOs, etc.  Valuation is essentially taking the idea of TVM to the next logical step.  Then you can start delving into financial modelling.  Free cash flows, discounted cash flows, ratio analysis, pro forma projections.  Start small, use a structured problem that gives you some inputs and just do calculations.  Bonuses* would be ideas of capital structure (really not necessary for entry level positions) like the M&amp;M theorems on capital structure (debt vs equity), portfolio management (risk management, asset allocation, hedging, investment strategies like straddles, inverse floaters, etc), and knowledge of financial institutions and banking regulations (Basel accords, depository regulations, the Fed, etc.).    Once you gain an understanding of how this works, pick something out there and do a report on it.  Then you'll be left with a single 'word problem' that gives you nothing except a problem and tells you to find an answer.  You'll have to find all the inputs and give reasons why these inputs are sound and reasonable inputs for this analysis.    A big part that people don't understand about projections and analysis is that **inputs don't exist in plain sight**.  You have to make a lot of judgment calls when making these assumptions and it takes a lot of technical understanding to make a reasonable assumption--of which the results of your report highly depend on.  As a finance student, you get a taste for all of this.  I'm gonna say it's going to be hard to learn a lot of substantial info in 2 months, but I'm not exactly sure what big business expects out of their grunts.  You'll mostly be doing practical work like desk jockey business, data entry, and other labor-based jobs.  If you know what you're talking about, you can probably work up to something more specialized like underwriting or risk management or something else.   Source:  Finance degree but currently working towards starting a (finance related) company to draw on my programming background as well. "A share of stock is a share of the underlying business. If one believes the underlying business will grow in value, then one would expect the stock price to increase commensurately. Participants in the stock market, in theory, assign value based on some combination of factors like capital assets, cash on hand, revenue, cash flow, profits, dividends paid, and a bunch of other things, including ""intangibles"" like customer loyalty. A dividend stream may be more important to one investor than another. But, essentially, non-dividend paying companies (and, thus, their shares) are expected by their owners to become more valuable over time, at which point they may be sold for a profit. EDIT TO ADD: Let's take an extremely simple example of company valuation: book value, or the sum of assets (capital, cash, etc) and liabilities (debt, etc). Suppose our company has a book value of $1M today, and has 1 million shares outstanding, and so each share is priced at $1. Now, suppose the company, over the next year, puts another $1M in the bank through its profitable operation. Now, the book value is $2/share. Suppose further that the stock price did not go up, so the market capitalization is still $1M, but the underlying asset is worth $2M. Some extremely rational market participant should then immediately use his $1M to buy up all the shares of the company for $1M and sell the underlying assets for their $2M value, for an instant profit of 100%. But this rarely happens, because the existing shareholders are also rational, can read the balance sheet, and refuse to sell their shares unless they get something a lot closer to $2--likely even more if they expect the company to keep getting bigger. In reality, the valuation of shares is obviously much more complicated, but this is the essence of it. This is how one makes money from growth (as opposed to income) stocks. You are correct that you get no income stream while you hold the asset. But you do get money from selling, eventually." "Sure they work - right until they don't. Explanation: A stock picking strategy based on technical indicators is at worst a mix of random guessing and confirmation bias, which will ""work"" only due to luck.  At best, it exploits a systematic inefficiency of the market. And any such inefficiency will automatically disappear when it is exploited by many traders. If it's published in a book, it is pretty much guaranteed not to work anymore. Oh, and you only get to know in hindsight (if at all) which of the two cases above applies to any given strategy." Most stocks are not actively trades by lots of people.   When you buy or sell a stock the price is set by the “order book” – that is the other people looking to trade in the given stock at the same time. Without a large number of active traders, it is very likely the pricing system will break down and result in widely changing prices second by second.   Therefore for the market to work well, it need most people to be trading at the same time. "What you're thinking of is more market making kind of activity, HFT algo's thrive on this; having information faster than anyone else. This type of activity could also likely be lumped into what is considered top-down analysis as opposed to bottom-up (which is what most mutual fund equity research involves). Again, the more important aspect is, what does the company you are applying to use!  Top-down analysis means that you are forecasting the revenue drivers for a company using macro-economic analysis. For example, let's say I'm investing in Chinese cement manufacturer's, what implications does Chinese interest rate policy have on infra-structure expansion and how does that drive revenue for this specific company. I might then look at margins, etc. to get an EPS estimate. Part of this could fall into secular  investing, too. Let's say I like LCD panel glass because of this consortium, I might take a look at 5 companies and then find the ones I think would benefit most from this. The problem with top-down is it tends not to be as much of a deep-dive, and its hard to pick individual companies because of it. Bottom-up tends to be more analytical and is what most pitches would be based around. The most important thing I'm not saying one is right or wrong, they are just different, and every investor has their own style.  Bottom-up analysis, which would be closer to what an equity research analyst would be doing on the sell-side, is analyzing what bottom-line indicators drive revenue and how are those expanding. For example, lets say I'm looking at search providers (i.e. Baidu, Google, Yahoo, etc.) I'd be looking at Cost-Per-Thousand-Clicks (CPTC) and number of clicks on the website. Multiply the two and I get revenue (very simplified version) for clicks business. I might then also forecast other revenue driving segments and try to understand how they are growing/pricing at an individual segment level (i.e. business services or mobile advertising). I'd then break down costs/margins for each segment and forecast those out. I could then get a forward EPS, get a range of multiples I believe it could trade in (i.e. I think the multiple will trade up/down), to get a target price. Also, I would likely do a DCF analysis on forward earnings to get a ""fair market value,"" and then try to triangulate a price. I would also be looking at stuff like management teams and industry trends, too, but bottom line, I'm pitching a company because I think it is undervalued and will outperform competitors **in the long run**. This type of work tends to be more research oriented and is what most (not all) mutual funds use when analyzing companies. Since mutual funds tend to have longer holding periods (2-10 years), as opposed to short-term, it's harder to justify investing in a company only because it has a short-term catalyst. Anecdotally, it's also easier to present in a written thesis because the numbers tend to be more concrete and easier to forecast than top-down (which have wider target ranges).  Your thought process that catalyst + industry context = market beating returns isn't wrong, it's just that every company thinks about investing differently, and it's important to tailor the report to that group's style." "No it's not. High frequency trading specifically aims to take a profit without speculating on the movement of price, using technological advantages and exploiting arbitrage opportunities rather than anything else.   Big firm trading I agree to an extent (that's why I made the comment that markets may or may not be efficient), but I think it's more nuanced than ""run a projection and see if the price goes up."" And as I say, traders at big trading firms generally have access to information and tools that we don't at home, so if you want to invest in something invest in it - don't try and guess where the price is going to go because people do that professionally and often still get it wrong."