Technical analysis is used in stock market trading to anticipate the movement of a stock’s price based on past price behavior, trading volume, indicators, and market theory. In addition to stocks, technical analysis may be used on other tradable instruments such as commodities and futures. Technical analysis is also useful to traders with different timeframes, like day traders who hold on to stocks for as little as 20 minutes and swing traders who may hold a stock position for days.

Technical analysis informs the trader when to get into the stock (the “entry level”) and when to get out (the “stop-loss level”). Factors taken into account as part of the stock price include stock fundamentals (the financial health and prospect of the company represented by the stock), stock news, stock sector news, and political news that may affect the stock.

Technical analysis is based on three important concepts: price discounts everything, price moves in trend, and history tends to repeat itself.

Although technical analysis takes into account factors impacting the stock, such as company fundamentals, macroeconomic situation, and buyer psychology, the concept of price discounts everything holds that all these other factors are already reflected in the current stock price. This only leaves the stock trader to analyze the impact of supply and demand on the stock (as reflected in the price movement of the stock).

Price moves in trend refers to the assumption that, once the stock price moves in a particular direction, there is a larger probability that the future price of the stock will continue to move in the same direction. Based on this, stock traders will “trade with the trend.”

History tends to repeat itself, on the other hand, is based on market psychology. Specifically, people tend to react to the same market stimuli in the same way. This can be seen in historical graphs of price movements. It is therefore profitable for a technical trader to study past historical price movements in order to effectively anticipate future stock price movements.

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Technical trading is typically concerned with identifying trends and trading with the trend, and one method of doing this is called the Dow Theory.

In keeping with the basics of technical analysis, Dow Theory assumes that the stock price is reflective of all available information, such as the earning potential and the management competence of the firm underlying the stock. The stock price also reflects the emotions and judgements of all market traders.

The Dow Theory recognizes two big trends: a bull and bear market. A bull market reflects the market, as a whole, being on an upward trend. The opposite is a bear market. These two big trends may last for a year or more. Within these two larger trends are secondary trends that can seem to go against the primary trend. There might be a period of stock price decline in a bull market (known as a pullback), or there might be a period of rising stock prices during a bear market (known as a rally). These secondary trends tend to last from 3 weeks to 3 months. Minor trends may also happen that last for less than 3 weeks, these trends are referred to in Dow Theory as “noise.”

In Dow Theory, before a trend can be established, it must be corroborated between two indices. A market index is a portfolio of securities that represents a particular section of the stock market. Under Dow Theory, the two indices that are used are the Dow Industrial and the Transportation indices.

Trading volume is an important indicator under Dow Theory that allows traders to anticipate price movement. A continuing trend is indicated by increasing volume, while a decrease in volume could signal a trend reversal.