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Technical Analysis: Use as Money Management Tool, Not Price Predictor

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Regardless of your approach, every investor has to make decisions about when to buy and when to sell, and charts provide a framework for managing trades.

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If there's one thing that you can rely on, it's the fact that the sort of steady action to the upside that we've seen over the past several months will cause some consternation among folks who feel like they've missed out. Invariably, they'll look to take out their frustrations and find ways to place blame. I was taken aback recently as I read some comments left for the writer(s) of the Big Picture column on the Investor's Business Daily website. There was a deluge of venom aimed at that venerable publication, and the gist of the complaints had to do with missing out on strong gains after IBD said that we were in a market that was "in correction."

Of course, those complaints were based on the flawed premise that IBD's "system" -- and by extension, technical analysis -- is infallible. If there's one thing that any seasoned investor will tell you, it's that there is no such thing as a Holy Grail when it comes to dealing with the market. I don't know of any chartist who's ever claimed that he or she has never been wrong, but there are plenty of folks out there who view technical analysis as a predictive tool. Anyone who's dealt with the market for any length of time will tell you, though, that there's no better way to get into serious trouble than trying to "predict" what prices will do.

While it's often overlooked, the most useful application of technical analysis is as a money management tool. Regardless of your approach, every investor has to make decisions about when to buy and when to sell, and charts provide a framework for managing trades. When the market is extended, you might be wary about chasing strength and start taking any gains you might have. If support levels are holding, you might want to do some buying, but if those support levels don't hold, you might want to make sure your losses don't get out of hand. The point is that charts give you a means of evaluating probabilities, allowing you to define your risk on every position that you have.

The most important thing, in the end, is that you have a systematic means of staying disciplined. It sounds trite, but investing success is all about cutting losses early and sticking with a trend while it lasts. Technical analysis is one means of establishing and maintaining that discipline, but while it's an exceedingly valuable tool, like every other approach to the market, it will leave you on the wrong side of the trade quite often.

I bring this up now because we are starting to hit earning season in full stride, and given the extreme nature of the move that we've seen over the past several months, it's hard not to be at least a little wary that some sort of "sell-the-news" reaction might be lurking around the corner. Nonetheless, the simple fact remains that the prevailing uptrend remains very much intact, and so far, there's been no evidence whatsoever of any weakness in the pricing action.

As such, I'll continue to hunt for long-side trades. One thing I will be looking for, however, is an increase in day-to-day volatility. A market that's been as strong as steady as this one has rarely falls apart all of the sudden. Folks who have been looking for ways to increase their risk exposures will do so into any dips, but if we are to hit at least a short-term turning point, we'll start see bounces as a means of selling into strength.

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No positions in stocks mentioned.
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