I first started to trade using technical analysis. Being trained as an engineer, statistics and chart reading is a much easier and faster way for me to learn to trade compared to looking at financial numbers. Secondly, without proper education in investment and in addition to the many "trading" books that I read and seminars that I have attended, the negative information about "investment" using fundamental analysis convinced me that technical analysis is a faster and more effective way of earning money in the stock market. Like most traders, because of my eagerness to profit from the stock market or you may also say my struggles not to loose money to the stock market, I just apply what I have read and learned from the so call "experts", without deeper thoughts and analysis with skepticism. Maybe, a series of discussion of my thought process to understand Technical Analysis, will help to structure my understanding of a preferred investment approach.
Like some of my previous blog, I always like to start the discussion of a topic with the definition of the term or topic of the discussion. It will always help to put everyone on the same footing before any further discussion. "Technical Analysis" according to Investopedia is defined as a method of evaluating securities for forecasting the direction of prices through analyzing statistics generated by market activity, primarily prices and volumes. It uses charts, indicators derived from prices and volumes, and other tools to identify patterns that can suggest future activity. I found the analogy on "Technical Analysis" and "Fundamental Analysis" described by Investopedia enlightening. Taking an example of buying a product in a shopping mall, fundamental analysis would go to each store and study the product being sold and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall to study the people going into the stores and decides to buy the product based on the patterns or activity of people going in each store.
From this analogy, the decision to act is purely based on the majority behavior represented in the form of an indicator, ratio or a pattern formed after a period of time. Almost all of these representation are defined by the Open, Close, High and Low Price and the Volume of transaction which can be measured down to tick level. It is this "majority effects" that causes the volatility in the price movement. "Majority effects" can be generated genuinely by institution buyers who believe in the value of the stock. But realistically, a lot of these "majority effects" are initiated from rumors or "experts" opinions that drive the greed and fear in the market. On the hind side, "majority effects" can also be generated by "powerful" speculators who has the resources to get real time market data to induce "false" perception in the market through highly sophisticated programs and powerful computers.
Knowing this important characteristic of "Technical Analysis", the question is whether are we able to trust the majority totally without knowing the value of the product you are buying before you put your hard earned money into the stock market. Are you comfortable buying something purely because majority is buying, without checking out the quality of the product? What is the chances that you will be able to catch the turn of every start of a "majority effect" given the limited resources and information that most investors have?
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