● What Is Technical Analysis?
Technical Analysis (TA) is a fancy name for something very simple
—the study of past prices, usually in the form of stock charts,
which is why practitioners of TA are often called “chartists.”
Chartists study stock charts to predict future prices.
Although this guide uses examples of stock charts, the principles work just the same
on any type of financial instrument, including forex charts, futures charts, market
indexes, etc.Now let’s get started.
Figure 1.1 below is a sample stock chart that a chartist might study:
The details of the above chart will be explained shortly, but as you can see,
there’s no reason to be intimidated. Technical analysis is almost completely
visual.
It doesn’t require a degree in finance or economics, nor does it require
exceptional
skill in mathematics. If you can read a chart, you can be a chartist.
● The Difference between Technical Analysis and Fundamental
Analysis
Most have heard of fundamental analysis (FA). In fact, it’s the stock market
investing
strategy that most are taught first. FA looks at things like earnings, cash flow,
debt or
any other financial aspects of a company, i.e., the “fundamentals” of a company.
“Fundamentals” can also refer to economic fundamentals affecting the entire stock
market.
A person using FA might study financial statements to discover what he thinks a
company’s
stock should be worth, then, if the stock is trading below that value, buy it hoping
to make
a future profit. In this way, FA is a stock market investing strategy concerned with
the inner workings of companies.
In contrast, pure technical analysis isn’t concerned with financial statements,
management
or anything underlying a company’s business. Chartists only study how stock
prices have
behaved in the past and how that could affect them in the future. A chartist using
technical
analysis might buy and sell stocks knowing nothing about what the underlying company
does
. As a result, pure TA is a stock market investing strategy not concerned with the inner
workings
of companies.
For an example, a person using TA might notice that in the past year, every time XYZ’s
stock
goes down to $25, it soon bounces back up to $35. He would then buy XYZ at $25,
hoping that
it will bounce back up to $35 again. He doesn’t necessarily know or care why XYZ has
been
bouncing between $25 and $35, but he tries to profit from it nonetheless.
● The Better Stock Market Investing Strategy: Technical Analysis or
Fundamental
Analysis?
The ongoing debate between TA and FA alone could fill up a book. Ever since
the concept
of TA surfaced, hardcore fundamentalists have been saying that TA is worse
than snake oil.
On the other side are the avid chartists who swear that FA is a waste of time
. Which is
the better stock market investing strategy? It depends on whom you ask,
but the answer
is probably somewhere in the middle. Take the following two successful
money managers: Jim Rogers uses fundamental analysis exclusively and ran The
Quantum Fund
along with George Soros in the 1970’s. For the 30 years that the fund existed, it averaged
over30% a year-- phenomenal results relative to other funds and the S&P 500 index.
When Jack Schwager, author of the Getting Started in Technical Analysis, asked
Rogers about technical analysis, Rogers responded, “I’ve never met a rich
technician. Excluding, of course, technicians who sell their services and make a lot
of money.”
On the other hand there’s Marty Schwartz, a money manager who exclusively uses
technical analysis. At the request of Jack Schwager, Marty had his past 10 years
of trading records audited. The results were that over the previous 10 years, Marty
averaged 25% a month, and during those 10 years, only suffered 2 losing months
of 2% and 3%-- results too consistent to be attributed to chance. When asked about
why he switched from fundamental analysis to technical analysis, Marty’s answer
sounded like a rebuttal to Jim Rogers’ comment: “I always laugh at people who say,
‘I’ve never met a rich technician.’ I love that! It’s such an arrogant, nonsensical
response. I used fundamentals for nine years and got rich as a technician.”
As you can see, there’s no consensus on whether TA or FA is the better stock market
investingn strategy; even the experts are divided. You’ll have to draw your own conclusions,
but if you should care to look, there are plenty of books and research papers arguing
both sides.
● They Can Be Friends After ALL
Even though experts argue about technical analysis vs. fundamental analysis,
don’t let that fool you into thinking they’re polar opposites. You can use both in
your stock market investing strategy, or realize they’re different versions of the
same thing. Indeed, many chartists treat TA as a short cut to FA. Jack Schwager, long
time chartist and author, elaborates:
“Technical analysis and fundamental analysis are more closely related than most
would lead you to believe…[most chartists] do not dismiss the relevance of fundamental
factors; they simply believe that price data incorporates and reflects these factors,
and the best way to understand
their impact on market behavior is to analyze charts.”
Others use both when selecting investments, using fundamentals for identifying
sound investments, and then using TA to time their buying and selling. William O’Neil,
founder of Investors Business Daily, is an advocate of using both TA and FA.
Charles Dow, founder of The Dow Jones Industrial Average, was also a man who used
TA and FA.
His Dow Theory resulted from a series of articles published in The Wall Street Journal
between 1900 and 1902. In fact, the Dow Theory is thought by many to be predecessor
to most principles of
modern technical analysis.
Regardless of how you use technical analysis, it should not be ignored completely. When it
comes to finding good stock market investing strategy, information is power, so you’re
not doing yourself any favors by ignoring the charts. While extremists deny the utility of
technical analysis, most reasonable people concede it has its place. Many major brokerage
houses hire chartists ,and the financial media often refer to it. At worst, learning TA will lead
to a more thorough understanding of the market; at best it will prove to be a valuable
money-making tool.
Patrick Abboud
info@capinco.com
facebook.com/capincos
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