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Is Technical Analysis Overrated?

By Bhakti Goenka

The markets are a complex reflection of human nature and their actions. With vast improvements in technology, real time data feed and automatic trading system, market analysis has improved by tenfold. Despite thousands of books being written on market analysis and countless theories attempting to explain the price movements of stocks and bonds, there are only two types of analyses at the heart of it – technical and fundamental. Fundamental analysis includes analysing a company’s financials and looking for explanations behind the movements of a stock price, while technical analysis examines historical price behaviour for predicting future price trends. Economic factors such as demand and supply laws use mass psychology that is closely linked to the human mind, as all minds tend to work in the same direction under a certain set of circumstances.

Technical analysis is equipped to assess the beginnings of sharp rises and falls in share prices, but it would take a gullible to overestimate its credentials and say that it predicts or forecasts all the moves correctly, in spite of what amateurs usually believe. Certain times the markets themselves are undecided, so there is no reason for an investor to choose between technical or fundamental analysis, as an ideal trade would come about from the combination of the two, fundamental supporting technical or vice versa. Relying solely on technical analysis gives us an incomplete picture of share price movements as we are solely depending on past price history and we completely ignore the micro and macro factors that are currently trending in the market that determine the direction and pattern of stock prices.

Technical analysis includes study of candlestick patterns, line charts, bar charts, momentum, oscillators, volumes, trends and moving averages by using various technical tools to analyse past price action of a security. Many investors expect the results and suggestions from professional experts or software codes and trends to be a hundred per cent accurate feeding into the myth “technical analysis can provide very accurate predictions.” But experienced traders will always quote a range and never a specific price because they know that it is about probability and likelihood, not guarantees. These price movements are based on volumes, momentum, and trends, and like previously mentioned, markets never follow standard behaviour.

While fundamental analysis does not remove this limitation either, it does focus on finding the security’s “true value” by analysing the company’s profit and loss account, balance sheet, ratios, its competitors and any other event actually affecting a business’ operations to give insight into the future scope of a company and where its stock prices might be headed. Unlike technical analysis, fundamental analysis focuses on the intrinsic value of a security and the viability of a company on a fundamental level. It is often both qualitative and quantitative in a way that it examines both numbers and factors that affect an investment’s value like interest rates, competition etc. Technical analysis, on the other hand, uses current and past price history as the best indicator of the future price predictions of that security. It relies heavily on charts, statistics and data, to uncover an investment’s strengths and weaknesses and helps analysts and investors decide whether it is a viable option or not and what kind of action must be undertaken for the same.

There have been multiple instances wherein the stock prices have been noted to reach a significant point of resistance (when a stock is moving in upwards direction, and it suddenly stops and starts moving downward) in the short run, but further along a few days the same prices smash through that resistance level and carry onto higher levels due to fundamental micro and macro conditions. This demonstrates that while technical factors can have a huge influence in the short run, fundamentals win in the long run. Again, this case does not follow every time and does not in any way prove fundamental to stand stronger than technical, but points towards certain shortcomings of technical analysis that make it difficult to work with in isolation.

Some traders denounce technical analysis as a study of charts and patterns without any concrete results whereas some believe it to be a Holy Grail which once mastered will unleash sizeable profits. These opposing views exist due to various degrees of training and experience traders have engaged in, but some of the most successful market traders with decades of experience trading and mastering technical analysis and its patterns stand sworn witnesses to the importance and usefulness of technical analysis in trading. Additionally, one of its major underlying assumptions considers fundamental analysis to be absolutely unnecessary as the price of a security is supposedly factored in the company’s financials, the economy, and overall market. But this only happens to be an assumption of technical analysis and most believe that a combination of both technical and fundamental is the best way to analyse stock prices.

It is clear that both technical and fundamental analysis play separate but equally vital roles in devising a trade. Technical analysis provides a wide range of tools and concepts for trading, which needs to be supported by the right trading psychology and stop loss points for a successful trading system. There are successful traders that use technical analysis and traders that don’t. But the bottom line that one does need to realize is that it gives a probabilistic range and one cannot expect to gain on every bet. Ideally, fundamental analysis is used to determine direction while technical is used to locate specific entry and exit points. There is no clear-cut method or formula yet to guarantee all trades to be successful, but most analysts do believe it gives one a better chance of success when both methods are combined.

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