August 5th, 2008The case for technical analysis
Fundamental analysis and technical analysis are two methods that investors (traders) use to narrow down the list of thousands of stocks into a single stock that meets their criteria of the day (minute) of buying or selling. With fundamental analysis of securities, investors make purchase or sale decisions based on analyzing financial statements, and determining a fair value. They buy when the market price is below their calculated fair value and they sell when it is above it.
Technical analysis, on the other hand, views financial statements as a waste of time. They view the market as efficient and maintain that all fundamental information is already reflected in any given stock price. They are more interested in the psychology of trading. Emotional responses to initial price movements lead to predictable and recognizable price chart patterns. The trend is your friend is their motto, and they jump in and out of stocks based on the initial price chart patterns that lead to a high probability of a predictable continuation pattern.
Years ago I would have sided with the fundamental analysts over the perceived voodoo of the technical analysts. But I recently came to my senses and have embraced technical analysis. I still use the fundamentals for a quick sanity check - is the company consistently cash flow positive and do they have a low or reasonable debt load. But I use technicals because they work quicker and more consistently then pure fundamental analysis. And in 2008 especially, I use technical analysis because the fundamentals are broken. Take a look at the wild price swings of a few 6 month price chart for 2008. Those wild price swings are the epitome of mass psychology, emotional responses, over reaction, under reaction, hysteria, confusion, and all things a keen understanding of technical analysis can help you capitalize on for the rest of 2008 and beyond. But the key is understanding the technicals better then everyone else.
Today’s recommended reading:
- Trading for a living: an older book written in 1993, but yet still very timely. Helps you dissect and understand your own emotional response the the markets - individual psychology - as well as the mass psychology of the market as a whole. But it goes beyond the psychology and breaks down all the key technicals, starting with a basic chart and and deeper into histograms, momentum, Williams %R, stochastic, relative strength and more.
- Technical analysis of financial markets: Slightly newer then the previous, last copyright in 1999. Not as much on the science of market psychology, but more in depth info on price gaps, continuation patterns, reversal patterns, Japanese candlesticks, Elliott waves, and other price cycles.

Trading for a Living: Psychology, Trading Tactics, Money Management by Alexander Elder

Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) by John J. Murphy



