Technical Analysis is the study of market action, principally
through the use of charts. Market action is expressed through movement
of prices and the volumes that accompany them. Prices and volumes are
therefore the only two variables to be studied when using technical
analysis. Technical analysis is the art of interpreting stock price
movements. Since financial market analysis involves some degree of
subjectivity, all of them are therefore an art and not a science (which
involves exact rules being met under all circumstances).
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Does Technical Analysis have any chance of working at all or is it just like reading tea leaves?
Since
technical analysis addresses the market, it is actually studying the
effect of action by all kinds of players. We know it to be a simple
stated fact that all effects are rooted in some cause. Technical
analysis is based on the fact that the market, which is made of all
participants, has more knowledge than individual players. It reflects
every market player’s opinion on the market. Technical analysis
believes that history and patterns repeat again and again A good
understanding of these underlying dynamics of market behaviour will
ensure that it works all the time.
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Still, why does technical analysis sound so esoteric?
This
is because there has not been a structured way of imparting this
knowledge to people. The methods originated in the West and it was not
until recently that information about technical analysis was at all
available in India.
Since it deals with an entirely new subject,
it has a jargon of its own which is unlike what we encounter normally
in the markets, and hence, it appears esoteric. Other reasons such as
ignorance, unavailability of information, no formal learning structure
and a general resistance of people to change are also why the subject
has remained relatively unexplored.
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I follow fundamentals. Should I know anything about technical analysis at all?
Fundamental
analysis addresses all variables outside the market whereas Technical
analysis deals with variables within the market. The objective of both
forms of analyses is the same – it is to find future direction of stock
price movements. Only the means of achieving the same differs. One of
the major advantages in learning technical analysis is that it enables
one to deal with market risk – this is one important area that is
completely ignored by fundamental analysis.
In a statistical study
done by Purdue University in the United States, it was found that the
major risk faced by investors were – in order of importance – market,
sector and stock. It is only technical analysis, which can give one an
insight into market risk. Hence a good knowledge of both technical and
fundamentals would produce a more rounded, well-informed, investor.
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Successful investors like Warren Buffet don’t seem to rely on technical analysis. Why is that?
Every
person in the market should choose his own style of investing. People
like Buffet are players over the very long term. This may sound easy
and acceptable but in practice, is a very difficult job to do. Not many
of us have such commitments to the very long term. Indeed, instant
gratification is almost the buzzword in the markets!
Warren Buffet
notwithstanding, it can be very conclusively proved that a proactive,
market timing based investment model will consistently outperform a
mere buy and hold strategy most of the time. There are always
exceptions to any rule. From millions and millions of investors the
United States could still produce only one Warren Buffet or one Peter
Lynch. They are the exceptions rather than the rule.
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Does technical analysis work as well in Indian markets as it does abroad?
Since
technical analy sis deals with the market and not geographical areas,
it will work in any free trading financial markets anywhere.
Aren’t
technical analysts like economists? None of them seem to ever agree on
anything. Since analysis is an art rather than a science, every form of
analysis, including technical and fundamental and economics (and maybe,
even tea leaves!) would leave considerable room for individual
interpretations. Non-agreement, therefore, is something quite common.
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Do you know what they say about Economists?
Well,
they make the weatherman look good! If everybody relied on technical
analysis, wouldn’t their collective actions itself distort the market?
The market is always residing in the future. Any form of analysis or
method, which seeks to project future direction of stock prices, will
develop a sense of self-fulfillment periodically, especially over the
short term. However, this in itself will set up a corrective cycle, as
human emotions of greed and fear will compensate for the seeming mass
action. Hence such distortions remain only over the very short term.
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There are so many theories in technical analysis. How do I know which one works the best?
The
many theories in technical analysis are all the result of consistent
and ongoing work in the subject. In essence, they are a series of
different ways of looking at the same set of variables – price and
volume. It is a bit like a jigsaw puzzle. Each different viewpoint is a
piece which when finally put together produces a complete picture.
There really isn’t one method that would work all the time in all the
market conditions. One has to pick and choose the method to suit the
market, sector and stock.
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Can I create my own charts or own technical indicators?
Consistent
development in the field of technical analysis (or indeed any field for
that matter) occurs because people manage to get out of straight
jacketed thinking and begin cutting radical new paths. Without original
thought, there can be no further progress. Hence there is really no
limit what one can create.
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I have no idea about technical analysis. Where can I learn technical analysis?
Fortunately
today, the availability of information on the subject is considerably
more than what it was some years ago. This in itself testifies to its
growing popularity.
Books are available from some of the
leading bookstores in major metros. They are all by foreign authors of
course. Yet, there hasn’t been a book authored by Indians as yet. On an
average, these books cost about $25 and upwards. The books range from
simple introduction to going as far as complex subjects like Fourier
transforms and Maximum entropy to highly statistical models of risk
assessment and asset allocations. Once one is more informed on the
subject, one can keep abreast through specialised magazines like
Futures and Technical Analysis of Stocks and Commodities, which are
published in the US. |