What is Technical Analysis?

Technical Analysis is the Study of Market Metrics to Determine Risks & Rewards

Risk & reward are related to owning & lending. Risk and reward are also related to modern portfolio theory. Once a decision has been made to invest, we need to determine when to buy. Later we will need to know when to sell. This is “market timing”. Technical analysis or TA for short is the key to timing the market well. This whole website is about different ways to time the market using Excel and technical analysis.

“The goal of Technical Analysis is to discern underlying patterns of orderliness in the apparent random walk of prices and to use such perceived structures as the basis for projections into the future of past price behavior. The ever-present danger in this endeavor is one of self-delusion: seeing patterns where none really exit and - worse yet - trying to use such patterns to predict the unpredictable

Dr. Paul Levine creator of MIDAS

shopping for good investmentsLet's assume our investor is a girl. When she is ready to invest, she goes “shopping”. Like all good shoppers she's looking for the best deal given her “risk tolerance” and “time horizon”. There are two ways to go about determining how good a deal a security is. There is technical (analysis) or TA and fundamental analysis or (FA). Neither type of analysis can give our investor an answer with absolute certainty.

Lets get one thing straight… Fundamental Analysts think Technical Analysts are on drugs and “seeing things” and Technical Analysts think “Funneymental Analysts” are clueless because they can't see the obvious patterns. Its a bit like religion. These two types of analysts are like “oil and water”… they don't (usually) mix.

Obviously since you are reading these we pages you know that I fall into the TA camp. I'm not a religious zealot though. I have no objections to fundamental analysis. It may well have a place in investors' arsenal of tools. And I do believe that over time… a very long time… the fundamentals do prevail. But markets are people and people are irrational… which leads to our first investment adage:

Markets can stay irrational longer than you can stay solvent

Let that sink in. Markets can stay irrational longer than the Fundamental Analyst can stay solvent. While the technical analyst lets her circuit breakers (her system stops) take her out when she's wrong; the fundamental analyst just keeps on waiting and waiting and waiting for the fundamentals to prevail. The fundamental analysts is like our Buy and Hold investor. Maybe you know him? He expects the market “get it right”. He demands the market “get it right”. He screams at the top of his lungs: Get it right DAMNIT! Which brings us to our second investment adage:

The market is always right!… its the analyst who is wrong

The question remains is how do we know what to buy and if its a good deal? How do we know when we should sell? The technical analyst goes to the numbers for clues… she studies the “market metrics” to find answers.

Those metrics could be any number of things. :) pun intended... They could be could be exchange prices (daily weekly hourly open high low close) they could be volume (number of shares trading) they could be number of advancing issues (stocks moving up) or number of declining issues. It doesn't really matter. The point a technical analyst looks at the “time history” of a given metric. The technical analyst is looking for trends and relative changes based on what has happened in the past. The technical analyst believes the past holds the key to unlocking the future

“The thing that hath been, it is that which shall be; and that which is done is that which shall be done, and there is no new thing under the sun” - Eccl. 1:9

While the fundamental analysts insists the future is not knowable and the TA agrees, the TA knows clues as to the probable future of a security are contained in the metrics and can be deciphered using TA. Numbers tell her not only what to buy but also when to buy and when to sell. TA provides the lense through which the market can be brought into focus! (This sounds like a silly promo for that TV show Numbers on FOX doesn't it). Oh well maybe so. The following quote from the obscure 1990's movie PI summed up nicely how we Technical Analysts think:

“ 12:45, restate my assumptions:
  • Mathematics is the language of nature.
  • Everything around us can be represented and understood through numbers.
  • If you graph the numbers of any system, patterns emerge.

  • Therefore: There are patterns everywhere in nature. Evidence: The cycling of disease epidemics; The wax and wane of caribou populations; Sunspot cycles; The rise and fall of the Nile. So what about the stock Market? A universe of numbers that represents the global economy. Millions of human hands at work. Billions of minds - a vast network squeaming with life. An organism...a natural organism. My hypothesis: Within the stockmarket there is a pattern as well. Right in front of me, hiding behind the numbers...always has been

    -PI... Darren Aronofsky dealing with a brilliant mathematician's descent into madness

    That's the gist of it. We look at numbers and assign meaning to them. That's really all there is to it.

    Is is TA science? No not really. Is TA and art? Oh yes most definitely! Does it work? That's up to you to decide. Why does it work? There are theories but honestly know one knows for sure. Believe me, being an Engineer and someone who likes to know how and why things work, that question has bothered me for a very long time. I don't have an answer. The bottomline is this… TA is an indispensable part of a decision making framework that does most definitely work.