There are many reasons I use technical analysis instead of some of the other analysis methods, but more importantly I have faith in it. Read on!
The other popular discipline is called fundamental analysis. This method of investing is essentially based upon fundamental ratios or as they are often called on Wall Street, multiples. Many followers of fundamental analysis also break it down further into a growth or value approach. The more aggressive growth approach is the hunt for stocks that are currently not registering any multiples (no earnings, no sales, etc.) and they are sought because of the analyst’s assessment that they have potential for growth. The value approach deals with good multiples (good earnings, good dividends, etc.). The value approach is what Warren Buffet uses. Gosh, if he uses it, it must be good. Keep reading!
One of the aspects of fundamental analysis is that it allows investors and analysts to spend an extraordinary amount of time hashing and rehashing an almost endless amount of data. Ranking multiples, reading analysts’ reports, screening for certain levels of earnings growth, ad infinitum. So you come up with a list of statistics you think might lead to a good stock and what do you have? Probably a list of stocks greater than 500! So then you start paring down on your statistical parameters to reduce the number of stocks. This is a hopeless approach as you are now tinkering with what you originally believed to be adequate. Even if you were to come up with a list of 5-10 stocks you thought you liked based upon fundamentals, what are you going to use to determine when you should buy and sell them? That is a key component to successful investing that most fundamentally-oriented investors leave out!
A few of these multiples are price-earnings, price-book, price-dividend, price-sales, etc. Starting to see a trend here? Almost all of those fundamental multiples utilize price, so why not just analyze price? Technical analysis is the analysis of price and price derivatives such as market breadth (advances, declines, up and down volume, new highs and new lows). See earlier article on price. Technical analysis gives you confidence in how you go about analyzing the market because it is based upon real numbers – the prices of stocks, ETFs, and market indices. The real numbers were created by everyone who has money in the marketplace, not by those who sharp shoot from the sidelines. It is not based on an analyst’s prediction, a usually flawed earnings estimate, or some new product that is going to revolutionize the industry.
In fact, most investors lose money in the market, not because of bad analysis, but because of the inability to transform their analysis into a sound method. Technical analysis helps overcome this shortcoming in that the analysis itself easily flows into action. Technical analysis is directly tied to the supply and demand of the market. Isn’t it odd that most economists are probably in the fundamental camp? The S&P 500 index is one of the components in the Index of Leading Indicators. Again, isn’t it odd that economists are always on TV to give market predictions when they use the market to predict the economy?
This is important! Technical analysis will greatly assist in keeping your human emotions at bay. Fear and hope have no place in the investment world. Bridging the gap between analysis and action requires that you overcome these devastating emotions. Deluded by emotions, one cannot begin to be successful at investing without some method of overcoming them – and that method is technical analysis. I have faith in Technical Analysis.
I evaluate the market based solely upon my technical model. I do not forecast or predict what the market will do; I just act according to what my rules-based technical model is telling me. Incidentally, Warren Buffet held large amounts of cash during much of the last two bear markets. I have the discipline to follow my method because I have faith in Technical Analysis. Sermon over.