Technical analysis: reading charts to make investment decisions

What is technical analysis?

Technical analysis is the study of past price behaviour in an attempt to predict future movements. Rather than examining a company’s financial results, the technical analyst simply looks at the chart: how the price has risen, fallen or remained flat.

The basic idea is simple: prices often follow patterns (recurring trends). If you recognise a pattern, you can anticipate what will happen next. For example, if a price has always rebounded at 100 € in the past, it might do so again.

This approach is based on three principles: (1) the market prices in all available information; (2) prices move in trends; (3) history tends to repeat itself.

The three trends and key levels

On a chart, you will see three main trends. An uptrend (or ‘bull market’): the price rises steadily, like a staircase going up. A downtrend (or ‘bear market’): the price falls steadily. A sideways trend: the price fluctuates between two levels with no clear direction.

There are two important concepts that help you interpret the chart: support and resistance. Support is a price level at which the share price tends to bounce back up (like a floor). Resistance is a level at which the price tends to stall and fall back down (like a ceiling). For example, if a share always rebounds at 50 € and has never exceeded 60 €, then 50 € is a support level and 60 € is a resistance level.

Identifying these levels helps to spot opportunities: buying near the support level (when the price is low) or selling near the resistance level (when the price is approaching its upper limit).

Simple technical indicators

To take their analysis a step further, analysts use indicators: calculations based on past prices that help to confirm a trend or identify changes. The most popular is the moving average, which smooths out day-to-day fluctuations to show the general direction.

Imagine a share with the following prices: 100 €, 102 €, 98 €, 105 €, 103 €. The 5-day moving average = (100 + 102 + 98 + 105 + 103) ÷ 5 = 101,60 €. This single figure tells you: ‘On average, where is the price situated? ’ If the current price is above its moving average, this is a bullish (positive) signal. If it is below, it is bearish.

Other common indicators include the RSI (which measures whether a share is overbought or oversold) and the MACD (which detects changes in momentum). But to start with, it’s enough to understand trends and support and resistance levels.

The limitations and risks you need to be aware of

Technical analysis is useful, but it is not infallible. The market can be unpredictable: unexpected news (a crisis, a merger, a scandal) can break all patterns overnight. Support and resistance levels are not insurmountable barriers.

Second risk: over-interpretation. Two analysts may look at the same chart and draw opposite conclusions. Technical analysis leaves room for subjectivity.

Finally, relying solely on technical analysis overlooks the fundamentals (the company’s results, financial health). The best investors combine technical analysis AND fundamental analysis (an examination of the company’s actual financial position).