I only use fundamental analysis in my due diligence because it’s the only one that makes sense to me, but that didn’t stop me from doing some side research into technical analysis.
I read a couple of very good books: “Technical Analysis for the rest of us” by Clifford Pistolese “Technical Analysis of Stock Trends” by Robert Edwards
My objective in doing so wasn’t to see which charts would indicate a “sure breakout” but rather to understand “fundamentally” the basis behind it. Basically if you were to ask “why” a billion times like an ignorant kid, what would the last reason be for it to work? Why should the chart be able to predict future stock price? A lot of the books I read focused on some fancy/complicated chart patterns, but the ones above helped better to explain my curiosities. Below are the conclusions I have found (as discussed by above and various experts in technical analysis):
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The Mathematical Reasoning: From a probability/statistic standpoint, an existing trend tends to continue. (It is mathematically more likely to continue the trend line than to break the trend). One could make a shaky connection to physics and law of inertia, but moving forward, if one were to think this way then the point of reading charts would be to identify chart patterns. And indeed, many if not all of the chart patterns are simply mathematically describing a change in trend, be it a change in the price compared to the moving average, or a change in the near term moving average to the long term moving average (I suppose the MACD) etc.
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Mutual funds buying: The concept here is making money by band-wagoning onto the mutual fund buyers or sellers. That is, if many mutual funds are buying into a position, this would over several trading sessions lead to the price of the stock to go up (because of the massive buying power). Someone using the charts and noticing the larger volume theoretically may be able to hop on for the ride so to speak (and hop off when mutual funds stop buying).
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Insider trading (bad/good news): Very similar to point 2, one theory is that insider trading does happen, and when for example some extremely bad news is found out by insiders, then the insiders would secretly mass dump all their shares before releasing the news to the public. And since the insiders would have so much stock to dump, their transactions would reflect in the chart. So while a value investor would think that a fallen angel is a buying opportunity, a technician would instead think that there must be something inherently wrong with the company’s outlook not yet released to the public.
So after I came to realize that these were the fundamental basis for technical analysis (at least from how I see it), I began to understand why I did not feel comfortable using it. Because the above points do not make fundamental sense to me (a post for another time), I felt like using technical analysis would be like doing physics where I am assuming that gravity means you go up. Perhaps for others they may feel differently about these three points (and may even have other points that don’t fit into the above 3), but still I believe that if one were use technical analysis, then they should do some work to at least understand mathematically what the chart is supposed to represent instead of just blindly following the charts as if it were some sort of magical sign (basically try to find some fundamental basis like one of the points above to latch onto). But to all their own.
Happy investing.
Submitted February 12, 2017 at 04:20PM by linlaoda http://ift.tt/2lFxX98
