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Rationalizing Technical AnalysisOne More Useful Tool for Successful Stock Picking
To many, technical analysis ranks as high as telling the future from tea leaves. But considering how many traders swear by it, there has to be more to it than that.
When traders analyze securities and make investment decisions, they are typically based on two rather broad approaches: fundamental analysis and technical analysis. In very basic terms, fundamental analysis delves into a company’s financials to determine its fair value. Technical analysis, on the other hand, takes a different approach. Technicians care little about a company’s or a commodity’s fair value. In a nutshell, what matters only are price movements. While technical analysis employs what many investors may perceive as exotic and high level tools, at its very heart are simply analyses of the supply and demand. The results of such analyses are then used to determine in what direction the market might be moving next; in other words, what is the current trend in the market. Although, without a doubt, technical analysis has its limitations, price movements; that is, analyses of supply and demand imbalances, could add very valuable tool set to any trader or investor. Rationale behind Technical AnalysisTrue technical analysts believe that only studies of price trends warrant both the time and effort put into it. What they are trying to say is that external factors, be they political, fundamental or psychological, will likely be reflected in the price one way or the other. So, why not simply analyze the price movements only? After all, consequences of certain economic events are the most visible in the price. Does anyone really care why a stock has moved upward or downward? Or, would investors rather find out what is next in store? Whenever a stock or commodity’s price surges, or plunges for that matter, there is usually an imbalance between the supply and demand. Analysts relying only on a security’s fundamentals typically want to know what is causing the imbalance. Technical analysts, on the other hand, are interested only in the fact that the price itself is fluctuating. Why Technicians Love Their ChartsBasically, “chartists,” as some technicians are often referred to, consider technical analysis as a prism of sorts, using it to break the “white light” into the sum of its parts and create a “window” through which they can get a much better view of the market. Of course, no chart is a crystal ball that can predict the future. But at least charts may explain what impact the current imbalance has already made, or could potentially have in the future, on the trend. In addition, technical analysis may take chartists a step further and help them predict whether there will be a trend continuation or reversal, and even how long it may last. The key reason why technical analysts love to “read” their charts is to spot trends. Upward movement is likely to continue moving upward until something happens to reverse it. Once there are signs of downward movement, more often than not, that shift is also likely to continue, at least for a while. What investors should bear in mind, though, is that no trend is permanently frozen in time. Eventually, it will reverse itself again, be it upward or downward.
The copyright of the article Rationalizing Technical Analysis in Investment is owned by Inya Ivkovic. Permission to republish Rationalizing Technical Analysis in print or online must be granted by the author in writing.
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