Tuesday, July 15, 2008

Technical Analysis (TA)

What is technical analysis? Simply put, it’s the art of analyzing the price action and behavior of a stock. Each day, investors put their money where their mouth is by placing their bets and announcing to the world what they feel their stock is worth. Because human emotion and psychology have changed very little over time, the underlying thought processes, expectations and anxieties that the buyer or seller was experiencing when they made their decision remains more or less the same today as it has throughout history. The stocks change, but the human aspect of investors entering into relationships with stock remain immutable. Hope, fear, and greed, when it comes to an investor’s wallet or purse is what technical analysis (TA) can capture the essence of. TA pays little attention to factors beyond price and instead focuses more on the underlying movement because price it is the truest measure of investor sentiment. Price can often discount changes in the company and the economy before they are reported in the fundamentals or economics, and this can sometimes make it a leading indicator for a story that is yet to unfold.

Here are a few questions that you may asked yourselves over the years and how technical analysis may help you going forward:

1) When is the proper time to buy?
2) When is the right time to sell?
3) My company just announced great earnings, so why is the stock now going down?
4) I've held this stock for years and it has gone no where. What should I do?
5) Why did I ever buy this stock? It has done nothing but go down since I bought it!
6) I have big gains in my stock, but how will I know where to take my profits?
7) My stock falls and Wall Street analysts keep recommending it. Why?

The technicals can help you with the questions above by offering you a "rules based" approach to handling your investments. Price action occurs in real-time, right in front of you, and without the lagging effect that other forms of analysis are known to have. The great thing about analyzing price action after a little training is that you don't need to over think a situation. The thinking has been done already by everyone involved in the stock; everyone positioned at a different price point, each with their own expectations of what will happen next. All of their hopes, fears and opinions have already been reported in the price with a date and time stamp.

Technical Analysis produces too much turnover
Contrary to popular belief, there are forms of technical analysis that are designed to keep you in a stock for the long-term as long as the stock is trending in your favored direction. It is quite possible and quite common to buy a stock that moves to a new high that emerges from a long period of sideways consolidation and price congestion without the chart ever producing a sell signal. The discipline of point and figure charting is an example of this, and this style of charting goes back over 100 years in history.

Technical Analysis is just lines on a chart
The lines on a chart are a simple way of representing points at which masses of investors joined together to place their bets at a specific price point as if their accounts were traded together as one, and thus, they will tend to act together predictably when key price levels are breached to the downside or exceeded to the upside, in the case of a support and resistance levels. The psychology of those investors together and their reaction to the "lines on the charts" could shift the balance of supply and demand for a stock one way or another, up or down. This is why it is very important to pay attention to areas of a chart where it cracked and broke down and where it began its long decline because that level will be a key area of selling pressure and excess supply in your stock (resistance) when it moves back up to retest that level.

Buying and holding stock is the best way to invest
Because most of Wall Street is designed around the buy and hold mentality as well as the majority of the products that are available to the public, there is strong evidence in support of this as well as established track records of long-term stocks and successful mutual fund companies. But what many investors fail to realize is that in between the five or ten-year time horizon that they have resigned their portfolios to, their stocks will frequently fluctuate 20-30% or more up and down due to economic and market cycles and company specific issues. Not paying attention to and taking advantage of these short-term inefficiencies in the stock chart undercuts the primary reason they are in the market in the first place, which is to make money. Learning to capitalize on these up and down trends in price could make a world of difference in the investor's bottom line performance.

Looking at a chart is too subjective
To the untrained eye, charts are absolutely subjective and open to interpretation. A trained technical analyst goes through the same type of schooling in pattern recognition and analyzing charts as a M.D. would in analyzing an EKG or X-ray, or an architect would in scrutinizing blue prints for a big project he or she was working on. These professionals would also assess their situations and make judgment calls on the health of their patient or building prior to surgery or breaking ground. Technicians are schooled with thousands of examples of what works, and what will represent successful and unsuccessful price structure. What may appear disorderly and chaotic to the average investor looks like an art piece to a technician. Just as an art historian would sit and analyze a painting, scrutinizing every minor detail and imperfection, a technical analyst absorbs the pattern before him or her on the chart, reading the story of its life and where it came from, its psychological health, how it has cooperated with or disappointed its investors through the course of time, and where it is likely to go in the short and intermediate-term.

Fundamental analysis is the best way of selecting stocks
Our view is that all forms of analysis, economic, fundamental and technical are all on the same team and need to work together to assemble the most accurate picture that the market puts before us, but equal credence should be lent to following the price action as it happens. Both endeavors can make investors money but a disadvantage of following company numbers exclusively is that price targets are usually derived using financials that over time can be effected by economic forces such as interest rates, inflation, competition from other companies, and obsolescence of a product or product line. Also, when a price moves decisively downward without any reported news, some may view that as a buying opportunity when in fact, caution should be warranted until the time is right to re-enter. A technical analyst will see that as a warning sign and either sell the position, hedge it or move to the sidelines while giving the stock the benefit of the doubt that it will go down further until it proves otherwise. To re-emphasize, we believe that the best of both worlds lies in being able to match the story of the reported financials with the price chart and using both to aid in the decision making process.

Technical Analysis emphasizes the trading of lower quality stocks
This can't be the further from the truth, when in fact technicals and the most popular price patterns work very effectively with stocks that are liquid and trade substantially more shares on average than smaller companies. Larger and more liquid companies have more investors involved in them and thus, the patterns that develop in the stocks tend to be more reliable. Larger companies are more apt to be "bought and held" and thus the emotions and psychology of the investors involved will likely ebb and flow more predictably than say, a stock that is the idea of the day on trading websites that trades for $5 per share. However, if you saw a major shift in price on any stock it should be paid attention to because it can be a precursor to a big upside or downside move regardless of how big the market capitalization is, or how low the quality you perceive the company to be.

It's too difficult to make long-term calls with just a chart
Even the best and brightest of long-term calls are often times found to be inaccurate because they were made based on information currently at hand, which in the long run is usually imperfect. Many things can change in the economy and with companies to go out farther and farther out with market calls. Even companies themselves change their outlooks and opinions frequently, swaying and humbling even the most astute and intelligent of predictions. However, technical analysis can give you a longer-term focus by using weekly and monthly charts that filter out shorter-term noise in a stock's price chart. This helps you stay on the right side of the market's tracks and stick with your winners that are trending upward in price.

It's irresponsible to invest purely on price momentum
This argument is frequently brought up by those who base their buy and sell decisions on PE or gross margin expansion, intrinsic value targets or by those that are unfamiliar with the benefits of technical analysis. Were it not for price momentum, intrinsic value price targets would not be achieved on a price performance basis, excluding dividends. All investors, fundamental, technical or otherwise make money in the market for themselves or for shareholders and clients from a stock going from point A to point B. At some point, value stocks graduate to become growth stocks and growth becomes value, but many times when stocks are sold when their fundamentally derived price targets are achieved, that could be the time when earnings really begin to accelerate, potentially leaving a lot of profit on the table. For those that use TA to assist them in selling their positions (i.e. remaining in the stock until the chart dictates it is time to exit), they just might have a huge potential winner on their hands based on the momentum behind the stock which TA can help you capture a significant portion of. If you know how to capture those price moves and trends regardless of where the stock is in its life cycle as a company (growing or mature), you may have an added edge over many investors. Adding to that, investors that shunned price momentum would never have owned Microsoft, Cisco, Wal-Mart, or any of the other greatest winners in our time.

Technical analysis is for trading, not investing
It certainly can be used for short-term trading as well as for establishing longer-term positions, but our opinion is that the lines between the definitions of trading and investing are often blurred depending on where the investor took their position and how they respond to this position after they made their commitment. If the investor bought correctly, it is much easier to hold the stock for a longer period of time because they will be more comfortable with it, and this will help them ride out the shorter-term price fluctuations.


Deepak Sahijwala said...

I would differ with your statement That "Technical analysis is for trading, not investing...".
I have been investing for over two decades purely on Technicals and have been quite successful at it...
Try the monthly averages and combinations with crossovers... check the results

BullTrader said...

Hi deepak,

Thanks for drop by.

For a basic, in order to invest beside looking at the fundalmental, It is also important to know on the technical side to avoid got squeeze. Fundalmentally sound stock we can use simple technical and that will enough if we were going for medium or longer term.

For non-quality stock or day/short-term trading it is better to have technically strong.

The best statement I would say, "Technical analysis is best for trading, useful on investing"

Cheers! :-)

peaceminded said...

To all TA supporters ,
added infos of idiot samghost as below :

Nick name : Firdaus (idiot samgoss)
Second home address : no 27, tingkat 1 , Jalan Tunku Hassan Seremban

Hse tel : 06 7632294

IC no : 720630055073

HP:016 2518129

Name : Firdaus (name addressed by his friends)

Nick name : Idiot samgoss

Blog address: www. samgang.blogspot.com

HP: 016-sam goss

Age : around 35+

Height : about 5 ft 9+

Weight : about 70+Kg

Occupation : Buisness man dealing with wood product n restaurant

Office address : Ikano , next to 7 eleven ( u can see his BMW parked infront of his office )

Home address : Kiaramas ,Mont Kiara , Level 18 lot no : 3.KL

If you ever see one 5 ft 9 spacky bugger driving a silver BMW 5 series with no plate WNX 2828,TA supporters , you should know what to do ^_^

He used to play golf in tropicana golf club every friday night. King spartan , whack this fucker kow kow for the pride of TA, will u ?