by Ken Long
To my way of understanding, technical analysis is the application of various forms of mathematical and statistical analysis to the study and description of the price movement of an asset (for me, a stock or an exchange traded fund usually) on a graph or in data tables, with the idea being that we can increase our understanding of the behavior of the asset. This increase in understanding may lead to identification of favorable trading opportunities going forward. This is a relatively humble claim compared to what some traders will claim for technical analysis.
Depending on the school of thought or the claims of the guru traders follow, technical analysis can go from a simple tool of description and classification all the way to being an insight that reveals the Universal Truth that guides the motion of planets and waves in the ocean and the psychology of the collective unconscious which connects all market participants at a very deep level. I have met traders who invest a great deal of their emotional wellbeing and considerable sums of money on their faith in the predictive power of their favored technical approach.
To be fair, I have met many traders who place the same or more faith in their ability to analyze and understand future price action of a company based on their reading of the fundamental analysis facts of their business operations and those of their peers and of the markets in general as a function of publicly disclosed financial documents.
I am not very interested in the philosophical disputes at the extreme ends of either sets of claims, other than to observe that the evidence for the slightest predictive power for either technical or fundamental analysis is so weak when examined in a scholarly way, that I don’t place any faith in the more extreme claims. If value cannot be found in the smallest of claims, I am reluctant to believe that the extreme claims bear much truth value.
For my methods of short term trading, with typical holding periods of 1-5 days, I find that fundamental analysis is pointless, since business conditions don’t change enough fundamentally to materially affect the price. When fundamentals appear to change however, psychology does seem to take over to move in anticipation of changes down the road, so it would be fair to say that reaction to news about fundamental changes seem to matter in the short term.
While I don’t believe that the technical analysis tools I use have any predictive power or Truth, I do believe they help me understand and describe short term market conditions in such a way that I can frame trades in terms of reasonable reward to risk ratios which let me venture into favorable situations for short term trading.
In this sense, then, technical analysis is neither true nor false to me, simply useful, with simpler being better.