March 14th, 2009Technical Analysis – Simple, Complex, and Black Swan
Technical Analysis defined – an investment or trading technique that bases buying and selling decisions on historical market data and trends.
Fundamental Analysis defined – investment or trading decisisons are based on the study of historical fundamental data such as earnings, cashflows, peer company studies, and general economic trends.
The technicians and the fundamentalists are like doctors and lawyers – constantly pointing out the flaws in each others logic, while claiming superior systems themselves. In reality, there are plenty of bozo technicians and fundamentalists out there. But the best and most successful traders are equally gifted at both fundamental and technical analysis. Here are a few thoughts on technical analysis.
1) Moving average – This is one of the simplest ideas in technical analysis. The idea is to create a smoother curve from market pricing points. For a 30 day moving average, each point on the curve would be the average of that days closing price and 29 preceding days closing prices. In theory (don’t try this at home!), you could BUY a particular stock when it closes ABOVE the moving average, and SELL the same stock when it is BELOW the moving average. Here is a chart of ISRG showing the extreme run up in its shares, followed by a plateau period, and a sharp share price decline. Perhaps the moving average indicator would have in fact worked here, but in most other cases, using only the moving average as your BUY/SELL indicator will probably lose you money.
2) Analysis Paralysis – Some people like to use and seek confirmation from multiple technical indicators before placing their BUY or SELL orders. Other people (a lot more than you think) use so many damn indicators that all they do is stare at the screen and paralyze themselves from any action.
3) Sometimes all those funny Technical Analysis indicators form funny Black Swan images.
4) The Simplest Investing Rule – If you want a good system for trading the S&P 500 on a longer term basis, then perhaps you may be interested in Karl Denninger’s simple rule. The rule advises to SELL when the 20 week moving average goes BELOW the 50 week moving average. And the BUY signal occurs when the 20 week moving average goes ABOVE the 50 week moving average. The image below is from Yahoo finance, and depicts SPY (ETF for the S&P 500), along with a 140 day moving average (20 week), and a 350 day moving average (50 week).
For another even simpler explanation of the simplest investing rule, check out the MAS informative and humorous take on the subject.
And if you still insist on learning more about technical analyisis, then check you should BUY and READ the following classic book, combining trader psycology with detailed technical analyisis information.
Trading for a Living: Psychology, Trading Tactics, Money Management by Dr. Alexander Elder
March 15th, 2009 at 3:27 pm
Great book, still working my way through it (along with the companion workbook).
March 15th, 2009 at 3:37 pm
Take your time on the book, TigerAl. It’s a classic and designed for a slow and methodical read, with occasional re-reads of your earmarked pages.
July 19th, 2009 at 6:30 pm
Just discovered this article while doing research to learn about moving averages and how to use them for investing. Maybe I’m missing something, but it appears the BUY & SELL signal explanation above might be reversed. The author states that we should BUY when the 20 week MA goes BELOW the 50 week MA, but the chart indicates that we should SELL when the 20 week MA goes BELOW the 50 week MA. Which is correct?
July 19th, 2009 at 7:32 pm
Bob, you are correct. Thanks for noticing – it was a typo on my part, and I have corrected the explanation. Also, feel free to google “denninger simple rule” – or something similar – to find his original explanation. And always remember that these technical rules are only guidelines, and not a science. If it were really that easy, everyone would be doing it.
July 20th, 2009 at 8:59 am
I’m a forms/documents designer/proofreader by trade, so just doing what I do best. Glad I could help. This is a fascinating and almost too simple method of investing. I read Denninger’s blog and he certainly seems to have his act together by providing info not found in the mainstream media.