I’m not a technician; far from it. The old joke is that technical analysts do two things very well: they know where to get graph paper really cheap, and they explain very well why their predictions went wrong.
That’s a little strong, even for me. But I’m loathe to try to guess where a stock or an index might be going based on some squiggly lines on a chart. I’d be even more loathe to invest a client’s money with a bottom-head-and-shoulders, a triangle pattern, or the Labor Day indicator as my only rationale. It’s certainly not something I’d want to try to defend in court.
Granted, technical analysis has come a long way in the last few decades, perhaps because computers have made it a lot easier to do the chart plotting. There’s even the professional designation of Chartered Market Technician that can be had to improve one’s expertise in the subject. I also believe that technical analysis can be a useful adjunct to other inputs in the very short term, such as in options trading. But it’s just not for me; that’s my—very biased—view.
As background, the Chartered Financial Analyst program (which I took years ago, but I stay up-to-date on it) drilled a couple of nuggets into my brain. One is that no analysis method is right for everyone; you have to pick one and stick with it. During the various market ups and downs, the style you’ve chosen will work better or worse than others at various times. But that’s preferable to trying to switch styles to accommodate whether the market is bullish or bearish or sideways or just volatile at the time, because you can’t build long-term expertise in one style by constantly switching to other styles.
For more background, there are three alternatives to technical analysis. One is fundamental analysis, or the analysis of a company’s or an industry’s balance sheets and income statements over various periods of time. You then try to construct a pro forma income statement and balance sheet, based on current capital market expectations, to conjure up what might be the future valuation of the entity relative to its current price. Fundamental analysis relies heavily on ratios such as working capital, debt/equity, earnings per share and the like.
Empirical analysis is popular especially with university finance academics, who publish research papers on a myriad of subjects. Empirical analysis concentrates on observed behaviour, such as the relationship between insider buying and selling and future movements in the stock price. A hypothesis is set, and then data is used to test that hypothesis to see if there is a relationship that is statistically valid, i.e. one that can result in consistent risk-adjusted excess positive rates of return in similar situations going forward.
Statistical analysis is favoured by some of the largest institutional investors such as pension funds, insurance companies and dedicated portfolio management firms. The object of the exercise comes directly from Harry Markowitz’s theory of designing the most efficient portfolio possible for a given risk level. Investments are chosen for inclusion or exclusion from the portfolio based on their expected returns, standard deviations, correlations with other securities and the like. What’s irrelevant to this approach is whether the investment is a pulp and paper stock, or an airline stock, or even a bond or a commodity. What’s important is its statistical properties and how it contributes to the portfolio as a whole.
As a comprehensive education program, the Chartered Financial Analyst program surveys all four of these approaches, but does not specifically endorse any one of them. What it does do is advise you to pick one and stay with it, so you can improve your expertise in that one over time.
For a do-it-yourselfer, that’s exactly the kind of discipline an investor needs to do the job right.