Technical Analysis: A Serious Investment Tool or A Sham?
Technical analysis is a touchy subject. When attempting to discuss what works in technical analysis (if anything), and how to use it to improve your investing success, one runs the risk of ruffling a few feathers.
Perhaps the best way to begin this topic would be to define what technical analysis really is, and here perhaps is the clearest definition I have found: Stock Market Technical Analysis, at its best, is looking at PRICE MOVEMENT ALONE in order to determine some course of action.
Now it is also important to note that there are essentially two heated sides of the subject, both with convincing arguments.
Those on the Technical analysis is a serious investment tool side argue that: Anyone who only looks at earnings but ignores emotions in the market is a fool because the market is made up of people who always bid things up beyond any reasonable value, and then sell things below any reasonable value. So ignoring market action is ridiculous.
On the Technical analysis is a sham side, the argument goes like this: The value of a company is purely determined by the fundamentals of that company's business and not by some silly wiggles on a chart. Therefore, the only reliable analysis lies in analyzing the company's business!
So both camps are firmly divided on this subject and it generally boils down to where you either believe technical analysis is useful or you don't. Speaking for myself, I believe that BOTH earnings and emotions matter, and while I place the major emphasis of any investment studies on the fundamental side, I also feel that technical analysis does have something to offer by way of price movement, trading volume, the 200-day moving average, and the beta of a stock. But charting stocks is a total waste of time. One may just as well be charting ocean froth for what good charting does!
Well then, how should an investor proceed? I believe the secret to successful investing lies in buying good values. And a stock can be termed a good value when it is cheap (meaning that it is depressed and selling below its intrinsic value). And how do we find such stocks? You find them using fundamental analysis. And you wait until the share price begins to recover in order to give yourself an added measure of safety. And you also want to be buying in an uptrend rather than a downtrend.
Investors Business Daily (IBD) ranks stocks based on fundamental indicators like earnings, and technical indicators like relative strength - which tells you how well a stock is performing relative to the market or its industry. In IBD, this is based heavily on the latest three months action. So if a stock has high relative strength, it's likely to be beginning an uptrend. Relative strength is based on the idea that the leading stocks are leaders for a good reason, and therefore are worth checking out.
One other example of useful technical analysis is the moving average of a stock's price. While a stock may fluctuate wildly over several days or weeks, looking at the movement of its average over a period of time can smooth out the fluctuations and let you grasp the underlying trend. And moving averages can also be a great way to significantly decrease your risk, and even improve your returns.
Jeremy Siegel, author of Stocks For The Long Run, actually tested the 200-day moving average rule, and he found that since 1886, using the 200-day moving average as your indicator, you would have earned 2% more (annually) than someone using a buy-and-hold strategy, and you would have done so with significantly less risk because you were only in the market about two-thirds of the time.
Finally, the more basic the technical indicator, the more valuable it can actually be. Relative strength is basic, but you can see its usefulness in spotting stocks starting to move. A moving average is also basic, and it has a nearly 120 year track record of success. But avoid the other hundreds of bizarre and complicated technical indicators out there because quite frankly, most of them contradict each other and therefore are not only quite useless, but dangerous as well!
* * * * *
Perhaps the best way to begin this topic would be to define what technical analysis really is, and here perhaps is the clearest definition I have found: Stock Market Technical Analysis, at its best, is looking at PRICE MOVEMENT ALONE in order to determine some course of action.
Now it is also important to note that there are essentially two heated sides of the subject, both with convincing arguments.
Those on the Technical analysis is a serious investment tool side argue that: Anyone who only looks at earnings but ignores emotions in the market is a fool because the market is made up of people who always bid things up beyond any reasonable value, and then sell things below any reasonable value. So ignoring market action is ridiculous.
On the Technical analysis is a sham side, the argument goes like this: The value of a company is purely determined by the fundamentals of that company's business and not by some silly wiggles on a chart. Therefore, the only reliable analysis lies in analyzing the company's business!
So both camps are firmly divided on this subject and it generally boils down to where you either believe technical analysis is useful or you don't. Speaking for myself, I believe that BOTH earnings and emotions matter, and while I place the major emphasis of any investment studies on the fundamental side, I also feel that technical analysis does have something to offer by way of price movement, trading volume, the 200-day moving average, and the beta of a stock. But charting stocks is a total waste of time. One may just as well be charting ocean froth for what good charting does!
Well then, how should an investor proceed? I believe the secret to successful investing lies in buying good values. And a stock can be termed a good value when it is cheap (meaning that it is depressed and selling below its intrinsic value). And how do we find such stocks? You find them using fundamental analysis. And you wait until the share price begins to recover in order to give yourself an added measure of safety. And you also want to be buying in an uptrend rather than a downtrend.
Investors Business Daily (IBD) ranks stocks based on fundamental indicators like earnings, and technical indicators like relative strength - which tells you how well a stock is performing relative to the market or its industry. In IBD, this is based heavily on the latest three months action. So if a stock has high relative strength, it's likely to be beginning an uptrend. Relative strength is based on the idea that the leading stocks are leaders for a good reason, and therefore are worth checking out.
One other example of useful technical analysis is the moving average of a stock's price. While a stock may fluctuate wildly over several days or weeks, looking at the movement of its average over a period of time can smooth out the fluctuations and let you grasp the underlying trend. And moving averages can also be a great way to significantly decrease your risk, and even improve your returns.
Jeremy Siegel, author of Stocks For The Long Run, actually tested the 200-day moving average rule, and he found that since 1886, using the 200-day moving average as your indicator, you would have earned 2% more (annually) than someone using a buy-and-hold strategy, and you would have done so with significantly less risk because you were only in the market about two-thirds of the time.
Finally, the more basic the technical indicator, the more valuable it can actually be. Relative strength is basic, but you can see its usefulness in spotting stocks starting to move. A moving average is also basic, and it has a nearly 120 year track record of success. But avoid the other hundreds of bizarre and complicated technical indicators out there because quite frankly, most of them contradict each other and therefore are not only quite useless, but dangerous as well!
* * * * *
posted by Bob Moser at
3:31 PM
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