Technical Analysis is the study of the markets using price action and data.
That’s probably the simplest way to describe it, but what does that mean?
To explain this I thought I’d take you through my own journey; my 30+ years in the City.
I started life as a Stockbrokers clerk and sat and listened to the analysts each morning saying what they knew about different companies and whether their analysis suggested one should buy, sell or hold.
I then moved into the Futures market, where I first started using charts, at the time on large pieces of graph paper, all Sellotaped together!
On the Futures Floor (I was in Sydney for a short time then on the LIFFE Floor in London for 10 years) it soon dawned on me that when an economic number or a bit of news came out the markets always responded, but sometimes not the way one was expecting.
The good thing about working in a room with 3000 other people is you could always find someone to talk markets with.
This is when I had my “Eureka moment”. One day a number came out and the market did the total opposite to what it should have done in response. “Why did it sell off when it should have rallied?”
I asked several of the sager operators who I knew on the floor. “Because it doesn’t want to go up” was pretty much the answer I got from them all.
So why do we need to worry about “why”?, I pondered… It was from that moment I decided I understood price action (the WHERE), better than the fundamentals (the WHY). Arguably that was the moment I became a Technical Analyst!
And that’s what I’ve done since, and today I look at 25+ markets a day across 4 different asset classes, and I apply very similar principles and methods. I am almost proud of the fact that some (many?!) of the markets I look at I have little to no understanding of from a fundamental point of view.
That’s not to say that you shouldn’t. I think the best traders in the world are those that can combine Fundamentals and Technicals (along with a solid understanding of how to manage a trade, a portfolio and their own minds, but that’s for another day!).
But for me personally I prefer to be separated (or is the word ignorant?!) from/of the Fundamentals.
Let’s pad this out a bit by looking at the three principles of Technical Analysis as defined by John J Murphy in the excellent “Technical Analysis of Financial Markets”; this from the second page:
- Market action discounts everything
- Price move in trends
- History repeats itself.
Let’s look at them one at time:
- This just means that everything is in the price. Everything. All known fundamentals, as well as sentiment, and this is important, because you may own a stock that you know/think is a good stock, but if the collective mass of the “market” disagrees then that stock will go down!
- The addition to this that I think is useful is “…and trends persist”. If it is clear something is going down then it will probably keep going down, and vice versa. Surely it is better to be on the right side of the trend?
- Technical Analysts look for recurring patterns of behaviour, be it on a minute-by-minute, day-to-day or month to month basis. Markets are run by human beings so human behaviour is a key element to understanding them. Pattern analysis and Candlestick charts use the premise that you can look for patterns that repeat and base your trades around this.
To sum up Technical Analysis is a useful tool for spotting trading opportunities and/or trends. This can aid you with respect to entry placement, stop management, trade management and where to exit. Your mind is a powerful thing and is naturally “wired” to have you fearing losses while being greedy and taking profits too early (those two words; Fear and Greed!).
One of my favourite books is Market Wizards by Jack Schwager and is a series of interviews with top traders. To a person they manage to find a way to reverse/mitigate this and cut bad trades early, while running good trades for as long as possible.
Technical Analysis can be a very good way of helping with this. As important as anything it can tell you where you’re wrong; where to get out if a trade is going wrong. Then you just need to have the disciple to actually get out!
My journey in Technical Analysis saw me become a member of the UK Society of Technical Analysts soon after the LIFFE Floor closed.
I took their yearly Diploma Course and passed the exam, and later went on to become a Member of the board, in fact I’m now the Vice-Chair.
I would recommend it to anyone who thinks that looking at the price history of something has some merit when deciding whether to buy or sell it!
So in summary…
Who is technical analysis for?
Anyone from a day trader to an Investor, across asset classes. As long as something it liquid you can chart it!
Mains risks of technical analysis:
Reliance on Technicals alone can be dangerous. It is a tool that can be used alongside and can compliment Fundamentals and proper trade management.
Main benefits of technical analysis:
A chart can help you decide what the trend is, where to enter, and where to exit, as well as where to get out if you’re wrong!