A definition of technical analysis seen recently:
“Technical analysis uses deviations from the efficient market hypothesis to make best guesses about future movements in the financial markets.”
I have a different take in my book:
Now here is where the understanding of technical analysis gets tricky. There are essentially two forms of technical analysis. One form is based on an ability to “read” charts and use “indicators” to divine the market direction. These so-called technical traders use methods designed to attempt to predict a market direction. Here is a great example of the predictive view of technical analysis: “I often hear people swear they make money with technical analysis. Do they really? The answer, of course, is that they do. People make money using all sorts of strategies, including some involving tea leaves and sunspots. The real question is: Do they make more money than they would investing in a blind index fund that mimics the performance of the market as a whole? Most academic financial experts believe in some form of the random-walk theory and consider technical analysis almost indistinguishable from a pseudoscience whose predictions are either worthless or, at best, so barely discernably better than chance as to be unexploitable because of transaction costs.” This is the view of technical analysis held by the majority—that it is some form of superstition, like astrology. Technical prediction is the only application of technical analysis that the majority of Wall Streeters are aware of as evidenced by equity research from Credit Suisse First Boston: “The question of whether technical analysis works has been a topic of contention for over three decades. Can past prices forecast future performance?” However there is another type of technical analysis that neither predicts nor forecasts. This type is based on price. Trend followers form the group of technical traders that use this type of analysis. Instead of trying to predict a market direction, their strategy is to react to the market’s movements whenever they occur. Trend followers respond to what has happened rather than anticipating what will happen. They strive to keep their strategies based on statistically validated trading rules. This enables them to focus on the market and not get emotionally involved.