Technical analysis gets a bad rap sometimes. Overconfident soothsayers and talk of astrology have shed doubt on the practice’s validity.
Yet technical analysis is simply the study of prices. And when you think about it, prices are the purest representation of the market. As Harry mentions, a trader knows immediately the result of his action – price proves every market participant right or wrong, without question.
That’s why I have a hard time understanding how any investor could manage without technical analysis. I’d think it would be like a pilot trying to fly a plane without a windshield. Sure, he has hundreds of gauges and dials, but if he can’t see for himself what is actually 10-feet in front of him… is it really safe to fly the plane!?
Technical analysis can be as simple as determining the current trend. Is it up? Is it down? Or is it sideways? Those are really the only three options. And even without moving averages or trend lines, anyone can determine a trend – do prices go from the bottom-left to top-right corners of the chart? That’s an uptrend. Or down they fall from the top-left corner to the bottom-right corner of the chart? That’s a downtrend.
Here’s a chart of the S&P 500 since late 2011. It’s a classic example of an uptrend.
Ignoring all the wiggles, a third-grader will tell you this market is moving up.
I chose my words carefully there. “This market is moving up.” It’s not a forecast; simply an observation.
Then there’s fundamental analysis, the study of a company’s earnings, profit margins and P/E ratio. Unlike technical analysis, it deals more with the “should bes” as they relate to stock prices. It does have a role in the process of choosing profitable investments but it introduces a layer of uncertainty in the decision-making process.
So you know a company’s earnings per share (EPS). But what does that say about its stock price?
Financial models attempt to answer this question. Formulas are created, which we can use to calculate fair value. Often, this “fair value” stock price doesn’t match the current market price – the real stock price. So is the stock overvalued? And how long will it take before the market realizes this? These are all questions that can only be answered, loosely, in the realm of theory and man-made models.
Prices, on the other hand, never lie. Look at a chart… check your quote screen… call your broker… the current price is the current price, that’s all there is to it. You can like it, love it or hate it… you can agree or disagree… but at the end of the day, the price is the price.
This holds well within Harry’s theory of bottom-up, network systems. There is no “top level” management team dictating what stock prices should be. Instead, “the people” get to vote, essentially.
And that’s the way it should be!