Fundamental vs Technical Analysis

Published: 01st July 2007
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Instinctively our minds are wired to detect patterns. Any person looking at a typical stock price chart will feel that he/she can predict where it will go based on where it has been.

How strong is the pattern recognition of humans? Consider the following demonstration (don't worry, you'll be able to read it):

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There are two basic approaches to investment research - fundamental and technical analysis.

Fundamental analysis involves actually sitting down and reading through the company annual reports and researching the industry as a whole.

Pure market technicians learn all they need to know from looking at the charts. Technical analysts have devised an entire mythology surrounding the future price projections by simply looking at a chart. They may only know the company by its ticker and have no idea what the company does. What's more they may boast that they do not even care.

Using little more than a ruler a technical analyst can draw various trend lines - primary, secondary, tertiary and can apparently tell you where the long-term price will go, but that any short-term predictions will be difficult to determine. Really? You don't say...

Elliot wave analysis uses a recurrent wave structure and has a various set of rules and counter-rules to explain how it supposedly works.

Then there are the head-and-shoulders formations, the pan-handle, and so on ... ad nauseum. Then for each of these, there seems to be an exception.

Should it not matter that the company issued enough stock to double the number of shares outstanding? What about payments on debt? Is revenue increasing or declining? How profitable was the last quarter? Are there recent labour, political, and/or environmental concerns? These questions should be of great concern to somebody purchasing shares in a company.

How exactly by looking only at a chart of historical prices and nothing else, can a prediction about the future be made? To me, this makes about as much sense as driving a car by looking out the rear window.

Why does technical analysis predominate? Is it just sexier? Maybe it's just a lot easier than reading through company reports.

Published on - May 30, 2006.

Video Source: Youtube

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