Everyday Financial Guide

January 9, 2012

What is Technical Analysis

Filed under: Investing — Tags: , , , , , , — thefranksteak @ 12:28 pm

Technical analysis is one of two major schools of thought of investing popular today. Technical analysts believe that they can predict investment performance by analyzing statistical data about past market activity.

The major goal of technical analysis is to create charts, mathematical formulas or computer algorithms will show future market performance. The main belief behind this is that the market follows similar patterns that will repeat themselves. Statistics can be used to identify those patterns and predict future market performance.

When you see advertisements for gimmicks such as trading robots you are seeing ads for technical analysis tools. People pay money for such things because they believe they will enable them to predict market behavior.

Efficient Market Theory

Technical analysts often believe in what is called efficient or rational market theory. That is the belief that markets always operate in a rational manner and will always properly price everything correctly. In other words the market price is always the right price.

Value investors (the other major school of investment thought) think that the market is irrational and often overprices or undervalues investments. A technical analyst only looks at the market data available for an investment. A value investor looks at the market data and the fundamentals such as the amount of cash a company has in the bank.

Technical Analysis and Speculation

Many value investors would argue that technical analysis is not an investment tool. Instead they would argue it is a speculation tool. Many day traders and high volume traders use technical analysis in an attempt to bet on future prices.

They believe that they can use statistics to figure out when they can sell an investment for the best price. This is called market timing and it is the thinking behind trading bots and many other technical analysis tools. The charts and computer programs are supposed to tell a trader when to sell or buy. Many people who follow them end up losing all their money because the strategy did not work out.

Critics of technical analysis contend that market statistics only show part of the picture. A company’s stock price and trading value will not show what its sales are or how much money it is making. High trading volume can mask other problems such as huge amounts of debts. In the past many stocks that were market favorites collapsed completely. Other factors that will affect the investment’s long term price are ignored.

Technical Analysis and Investment

Technical analysis is not a good strategy for average investors because it was designed for speculation not investment. Most strategies involving it are designed for high volume traders that want to make a quick profit. Persons investing for the long haul will not profit from regular buying and selling.

A major draw back to this analysis is that it often necessitates frequent buying and selling of investments. This cost the investor money in the form of brokerage fees and commissions. It is why brokerages encourage technical analysis and often give away free TA tools or programs. They want you to engage in it so you will trade more and pay more fees.

The average person should follow other strategies such as modern portfolio theory or value investing. These may not be as flashy but they will not cost you a fortune in brokerage fees.

Steven Hart is a freelance writer and a Financial Advisor from Cary, IL. He writes about Annuity topics like Single Premium Immediate Annuities, What is an Annuity, and Current Annuity Rates.

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