Technical Analysis – An Outsider’s View of the Inside?

For the longest time, there have been a debate as to whether fundamental or technical analysis is the best form of analysis to perform when one wants to make a trading or investing decision. The debate to which I’m referring has been going on for decades amongst the professionals of the financial markets. In my opinion, both are great but I’m gonna attempt to outline why this debate is really pointless. But first, let’s breakdown what both forms of analysis entails….

Fundamental analysis is when a trader or investor views macroeconomic factors such as supply and demand (if we’re talking commodities), a company’s financial records, management, future direction of the company (if we’re talking stocks), central bank policies (if we’re talking Forex/Foreign Exchange). As you can see, fundamental analysis is preferred by those who plan to hold on to a position for a long time (weeks, months, years). It would probably be more appropriate to label fundamentalists investors, at least for the most part. There are some fundamentalists who trade short-term because a fundamental development can shake the markets in a major way and to be on the right side of one of those fundamental moves can yield big profits really quickly. To get an understanding of what I’m describing, simply monitor the markets anytime a major economic indicator is released or when the Federal Reserve chairman speaks.

Technical AnalysisLet’s now define technical analysis (price action). Technical analysis has more so to do with a trader monitoring the inside of the markets themselves to determine buying and selling points. The main objective of a technical analyst is to identify a trending market in which there is an uneven balance of supply and demand. To do this, the technician would study the movement of an instrument’s price. What the technician is looking for are patterns in price would could give him an idea of where prices are likely headed. Some use indicators that identify overbought/oversold conditions, moving average convergence divergences, etc. Indicators are problematic because they usually lag, meaning, by the time you receive an indication, the trend is damn near over.

Now that you have an idea of both forms of analysis, let’s discuss whether or not technical analysis provides an inside view of the markets from the outside.

Contrary to what many believe, your average trader isn’t going to have access to all or even half of the fundamental information that the major players will have access to. By your average trader, I’m referring to the person trading from home or even small trading firms. It’s a well known fact that the Hedge Funds, Investment Banks and other major players will have first dibs on any major news. They will act on this news, as in buying or selling, long before the public ever finds out about it. A typical scenario goes like this: the at-home traders are sitting at home monitoring the markets and all of a sudden, they notice a huge spike in buying or selling in certain instruments. They check their news sources only to see that there’s no breaking news or anything significant occurring to explain the sudden spike in prices. Then, a few days later, a news story is published which explains the buying/selling caused by the institutions. I know some of you are reading this and are beginning to feel that it’s hopeless and that the little guy doesn’t stand a chance, but hold on…..

This is where technical analysis comes into play. When done properly, technical analysis offers the little guy a look into what the institutions may be up to. Even though the institutions may have access to information to which you have no access, however, it is impossible for them to hide their tracks. What I mean is: when you look at a chart, it will explain all of the buying and selling that has taken place. All of the bars on those charts represents the institution’s buying and selling. No small trader has the ability to move the market as in making bars appear on the screen, only the institutions can do that. By paying close attention to an instrument’s price action, one can tell when an institution is buying or selling. Be advised that institutions don’t do all of their buying and selling at once — they scale into their positions over time in an attempt to make it appear on the charts that the markets are in balance. They do this because as I mentioned previously, they know that it is impossible for them to hide their activity completely. But if you’re able to anticipate their moves, you can simply piggyback on to one of their trades and make a substantial sum of money.

With that being said,  it is for this reason that most technicians don’t even bother watching the news, they just observe price action. They live by the belief that all of the information that you need to know is already reflected in the prices….which is true. Why? Because, as I explained earlier, the institutions have access to information way before the public ever does. By the time the public finds out about an event, that event has already been priced into the market. Technical Analysis is also founded on the idea that markets will behave in a similar manner under similar conditions based on human psychology. To prove this, only thing one has to do is study centuries of price charts. What the person will instantly notice is that the charts don’t look any different. In fact, this is how Paul Tudor Jones (PTJ) was able to anticipate the Black Monday Crash of 1987. PTJ and his statistician simply took a chart from The Great Depression era (1929) and compared it to a chart of their current era and found a 90 plus percent correlation. For that reason, PTJ was able to position himself on the right side of the market when it crashed on October 19, 1987.

Conclusion: As stated previously, the average trader isn’t gonna have access to the information that the major players will have access to. But through price action analysis, the little guy has a chance to see what the institutions may be up to and if they’re correct, they can jump on board and earn a lot of money! Don’t think for one second that price action analysis is some magic bullet that catapult one to riches. It’s possible for you to be wrong on more than half your trades, but if your risk management is strict, you can make huge profits despite being wrong most of the time. I’m also of the belief that technical analysis shouldn’t be used to make long-term investment decisions, only short-term trades. In closing — this article isn’t to discourage anyone from employing fundamental analysis in their trading decisions. Truth be told, the most profitable systems I’ve ever seen are those that use both fundamental and technical analysis. Better yet, I’ll quote billionaire trader Paul Tudor Jones when asked about fundamental and technical analysis:

“Technical analysis:  “Made well over half the money that I’ve made in my lifetime.”
“Fundamental Analysis:  ” Made the rest.”

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment.

Advertisements

8 thoughts on “Technical Analysis – An Outsider’s View of the Inside?

    • FYI: There are two forms of technical analysis. There’s predictive analysis and reactive analysis. I don’t try to predict the market, I simply react to trending markets and have been profitable in doing so.

      Like

      • The markets aren’t random all the time though. I’d say that 90% of the time, the markets are random/efficient. During those times, I do nothing. But there are times when either bulls or bears are dominating the market which result in a trend. Look at the DJIA futures for example — were we not in a strong bull trend the first 5 months of the year? By looking at the price action setup, it gave a bull signal to enter.

        I would also like to see where T/A was “proven” inadequate especially when billionaire Paul Tudor Jones and other prominent traders have stated that T/A was used to make half their money.

        Like

  1. Technical is a quantitative way, to be fair, but simplifies and reduced for non-quants. If you have the ability, use quantitative analysis instead

    Like

    • Technology neutralizes the playing field. Most trading platforms will do the calculus necessary. Technical analysis is backward looking. Historical looking metrics should not be used to make decisions on future investments. There are forward looking metrics that use fresh realtime data. And they’re incredibly accurate compared to any backward looking form of analysis.

      This should be investing 101. “Past performance is not indicative of future returns.”

      edit: not trying to attack, just trying to inform others of the dangers of vulgar investing.

      Like

      • True a lot of empirical approaches has great filter system to outright the bias, and also accurate when only dealing with microstructures. But you are right no one should just look at historical data and trade.

        Like

      • One more note, historical data is total BS when looking from low dimension. Cannot say the same thing for vector machine as I saw some good system based on that.

        Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s