Finance

The Philosophy of Technical Analysis Pt 2.

Let’s get back into it 🙂

Technical vs. Fundamental Forecasting

Most traders like to classify themselves as either being on Team Technicians or Team Fundamentalists. Both work to determine the direction prices are likely to move. They just approach the problem from different directions.

D: Uh, what are the differences between technicians and fundamentalists again? Who should I hate?

The fundamentalist studies the cause of market movement, while the technician studies the effect.

D: Wait…I thought the “fundamentals” meant relaxing crazy stalking powers.

It’s true in the sense that you don’t need to be a crazy stalker like was described before. However, a fundamentalist focuses on the overall economic forces of supply and demand that cause prices to move high, lower or stay the same. They look at relevant factors that affect the price of the market to determine the intrinsic value of that market.

That intrinsic value is what fundamentalists use to then gauge if the market price is over or under priced.

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Once again, a technical analyst just concentrates on the study of market action. The effect is all she cares about. Causes and reasons aren’t necessary.

D: Okay. Technical analysts just don’t care about what other people think. 

In reality, there is a lot of overlap. Many fundamentalists have a working knowledge of the basic tenets of chart analysis. Many technicians have at least a passing awareness of fundamentals.

D: So why Team Technicians over Team Fundamentalist? Fundamental analysis sounds logical as well. Why can’t I do both (because you know…all of a sudden I’m an overachiever.)

The problem is that the charts and fundamentals are often in conflict with each other. Usually, at the beginning of important market moves, fundamentals do not explain or support what the market seems to be doing. It is at these critical times in the trend that these two approaches seem to differ the most. Usually, they do come back into sync at some point, but often too late for the trader to act.

One explanation for these seeming discrepancies is that market price tends to lead the known fundamentals. Stated another way, market price acts as a leading indicator of the fundamentals or the conventional wisdom of the moment.

While the known fundamentals have already been discounted and are already “in the market,” prices are now reacting to the unknown fundamentals. Some of the most dramatic bull and bear markets in history have begun with little or no perceived change in the fundamentals. By the time those changes became known, the new trend was well underway.

After a while, the technician develops increased confidence in her ability to read the charts. The technician learns to be comfortable in a situation where market movement disagrees with the so-called conventional wisdom. A technician begins to enjoy being in the minority. She knows that eventually, the reasons for market action will become common knowledge. It is just that the technician isn’t willing to wait for that added confirmation.

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In accepting the premises of technical analysis, one can see why Team Technicians believe their approach is better. Because remember, the technical approach includes the fundamentals. If the fundamentals are reflected in market price, then why study the ever-changing levers. Chart reading becomes a shortcut form of fundamental analysis. The reverse, however, is not true.

-D

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2 thoughts on “The Philosophy of Technical Analysis Pt 2.

  1. This is a great introduction to this subject. What would make it even better would be concrete examples of how these different views address particular stocks and markets. I’d like to hear a little more about real world application, so I can grasp the theoretical distinction better. It is my experience that people comprehend distinctions best if said distinctions can be illustrated.

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