The reason Technical Analysis works is amazingly simple. No we are not worshiping charts as if they have god-like powers. Our belief in charts is actually very sound.

When someone sells a stock, they take out a buyer, and that forces the price of the stock to go down (while increasing volume). Let’s say some huge entity decides they are going to buy a stock every time it is under 140 and sell it every time it is over 145. If they are pushing a huge order in each time, imagine the effect on the instrument. Over the course of several months, we’d see the stock bounce off of 140 (as their buy orders triggered and pushed the stock up) and hit extreme resistance at 145 (as their sell orders triggered and pushed the stock down). A chart of this price action would look something like this:

bond futures consolidation chart

Over time, others would see this pattern and start to buy at 140 and sell at 145. Thus a trend channel is born.

People make stock trades (even when computers do, people program the computers) and reading a stock chart is like reading the minds of traders. You see what they did in the past and you can use that information to predict what they will do in the future. Technical analysis is like combining psychology and finance.

Using mental key points, chart technicians have developed many fancy named shapes that occur on a chart. Remember, in every case (of geometric analysis), by looking a price and volume charts, we’re reading the minds of the people trading the stock.

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