Dale Jackson

Personal Finance Columnist, Payback Time

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Those multi-coloured charts with lines running in every direction and sideways hash-marks can be enough to put anyone off. Even multi-billionaire Warren Buffett is famously quoted as saying, "I realized that technical analysis didn't work when I turned the chart upside down and didn't get a different answer." 

But whether you understand technical analysis or not, it can be a valuable tool to help make investment decisions. There are several different technical methods and tools to predict market trends thanks in part to the increasing popularity of computer-assisted techniques.

Here are a few basics to understand how technical analysis works:

Technical analysis is a method of valuing securities by analyzing past activity to determine trends. In other words, it looks at the past to determine what will happen in the future.

It determines trends through a variety of technical tools that track data such as price and volume. If a stock price is rising and the volume is decreasing, the trend could be breaking and it might be time to sell. Inversely, a declining stock price could present a buy signal if volume is waning.  

A moving average is used to spot trends by flattening out large fluctuations that come from one-time events.

Time periods are determined by time horizon. If an investor is looking for a short-term gain, the sample period will be shorter.

Here are the truths to a few common myths about technical investing:

Results are not always right, but right more than wrong. If a security has done the same thing 75 per cent of the time in the past, it is likely to happen again – but not guaranteed.

Interpretations can be subjective. Good technical analysts are trained to read trends and have plenty of real world experience, but not all read the signals the same way.

Technical analysis does not attempt to quantify a security's intrinsic value. A fundamental analyst studies the actual nature of a security, while a technical analyst is not concerned with such fundamentals as corporate profits, supply and demand, or quality of management. The technical analyst believes that sort of information is already priced into the market.

Technical analysis complements other types of analysis. If you prefer fundamental analysis to value a stock, it never hurts to run it through the technical ringer before making a trade.