Does Technical Analysis Really Matter?

By Branden Rife  MAY 26, 2009 2:15 PM

Yes -- and here are 4 reasons why.


For years, people have asked me if technical analysis really matters. In a word, yes.

For all of those who think technical analysis is voodoo and totally worthless, think about it this way: Charts are a historical depiction of valuations the market had previously assigned to a business and/or its industry. What valuation metric the market is applying is completely dependent on the industry, and most importantly, on the company itself. You’ll find that charts of an applicable valuation metric also happen to have their own support and resistance levels.

The reason why true breakouts and breakdowns (not just a quick fake-out spike or wiggle) are viewed as so important isn't because people have an inherent affliction with geometric shapes, or  think the market is a bigger version of Nintendo. It's simply because they show the market is accepting a new valuation level that's above or below a previously accepted level. That's why charts that literally “breakout” of patterns such as long bases or ranges, are so widely spoken about. The same can be said for trend lines, compression patterns etc. The reasons for accepting a new level of valuation are vast, but typically it centers around an underlying current or future catalyst.

Technical indicators are a whole different ball of wax because almost anything can be considered an indicator if you really want it to be. The bottom line is that they help with determining points of exhaustion, accumulation, confirmation, rejection, regression or divergence through a myriad of formulas or disciplines that usually involve the mathematical fun you learn in Algebra II and Calculus.

Some indicators have become rather standardized (and less useful), while others can be modified for better accuracy. And then there are the indicators (formulas) of which the mathematics in the above courses are merely an appetizer. You can thank Isaac Newton (or Will Leibniz) for those. The formulas and algorithms that work best are those which -- for obvious reasons -- you'll never hear about. Jim Simmons’ firm Renaissance Technologies is a good example of that.

Fundamentals are the ultimate arbiter of price, but the technicals help identify when the market’s perception of said fundamentals and/or valuation is changing. There are a plethora of rules that need to be respected when blending technicals with fundamentals. Hopefully you'll be able to learn some of those from the professors in Minyanville who practice the art.

I've spent the better part of 15 years perfecting my craft. And because the market is an ever-changing beast, I find myself having to occasionally tweak my work to align it with the current market environment, or the environment I foresee the tape morphing into. You must always be a student of the market. Anyone who chooses otherwise will be supremely humbled at some point.

I've found that those who scoff at technical analysis typically do so merely because they don't follow the 4 basic rules:

1. Understand the craft and its rules, patterns, etc.;

Understand the indicators;

Know how to apply number 1 and 2;

Have the discipline to respect the signals of technical analysis because it goes against their opinion.

There are many different styles and techniques out there. Whichever you use or choose to use in the future, the most important thing you must never forget is to stick to your discipline.
No positions in stocks mentioned.

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