The term “technical analysis” sounds like a complicated term but simply put, it is the action of trying to forecast future prices by looking at how prices have historically acted.
Technical analysis is often also referred to as charting because charts are made of historic price movements with a view to matching them with the current market conditions.
The charts take into account such things as the general trend of prices, previously tested low and high prices etc.
Some market participants conclude that technical analysis is akin to reading tealeaves and is a waste of time. Others though, realize that technical analysis is a focus of past events created by human behaviour and since human behaviour is behind the current markets, it should not be cast away as useless at all. They may make decisions largely based on the findings and signals emanating from historical charts.
Regardless of which way you feel, technical analysis can provide you with a way of improving the odds of your trading success, even if slightly. Most participants use technical analysis to reduce risks and to better time trades which they already have identified by other means. Gaining this edge can be very useful.
Technical analysis vs. Fundamental analysis
Fundamental analysis is a way to determine what the price of a stock should be based on fundamentals such as a company’s revenue, earnings, growth, net asset value and similar tangible evidence. This leads to a price that a stock should be trading at, but seldom is the price that the stock actually trades at.
If everything worked in the favour of fundamental analysis we would calculate the value of shares and they would remain at that value until some new information became available so that we can start the calculation again. There would be no way to make money out of the market – because all stock prices would remain static. Only on new, unknown factors would you make money.
Whereas fundamental prices can be created with a calculator, actual market prices are open to interpretation because of these many unknown factors, just as the price is.
This is why some property management companies actually trade at less than the current worth of their property assets in a down turn. Investors believe that the property portfolio might be worth less in the future and so are unwilling to pay the current value.
Negative aspects of technical analysis
Whether a price is cheap or expensive depends on where you think the price is going. The historic value will be a factor but dwelling on the past may not always help.
You may find that the charts of some stocks will give you several different signals for future movements. Furthermore your own personal bias towards the stock may lead you to choose the ones you favour. Objective technical analysis is rather difficult to do.
Positive aspects of technical analysis
The movements of stock prices tends to be not totally random but in trends. The trends may serve to provide an overall picture of expectations. This is why technical analysts, whilst aware that they are working with historic data, feel that the data is valuable all the same.
Trends, supports and resistances on charts are well known and easily identifiable. They are so widely known about that they may be in most people’s minds as they trade – and this can lead to a self-fulfilling prophecy.
Examples like this are well documented – this is effectively the basis of technical analysis – a measure of predictable human reactions.
