Many so-called financial professionals as well as academic experts debunk technical analysis or TA: the study of charts in an attempt to uncover future trends in market activity. The venerable Efficient Market Hypothesis, the bible in American Business schools, insists there is absolutely no value in this arcane art. Yet, over the last six months technical analysis has been one of the few tools that have helped me make sense out of the stock markets. Go figure.
Unfortunately, TA is not an exact science and I am by no means an expert in understanding all those diagonal lines and geometric figures of chartists. For me, it boils down to this: a stock (or any other security) once in motion, tends to stay in motion. Most often, I use TA in combination with fundamental analysis and price momentum. It helps me identify trends within financial instruments whether stocks, bonds, markets, currencies, or commodities.
Many prominent scientists decry technical analysis as Voodoo and with terms like “head and shoulders”, “neckline” and “pennant formation”, I can almost see their point. . I remember sitting in my MBA classes at NYU listening to my learned professors drum the same message over and over in my head. They claimed, according to this Efficient Market Hypothesis, that markets are so efficient that all available information is already discounted in stock prices and that an individual stock’s future behavior is random or at best, a guess. Some argued that even insider information is fully discounted in price action. Intuitively, after 28 years working in financial markets, I find that hard to believe.
Take the last year and a half as an example. In 2007, we had a lot of volatility and three significant corrections. By the end of the year the S&P 500 had only gained 3.5%. Yet, at times during the year, the market was substantially higher before finally peaking at a new all-time record in October. Since then the markets have only increased in volatility. By Christmas, it wasn’t difficult to figure out that the economy was slowing, sub-prime problems were increasing and a looming credit crunch was upon us. Everyone knew or at least suspected that. The question was how bad would it get and how much had been already discounted in the markets?
Fundamental analysis couldn’t answer that question because there wasn’t enough data out there, which was the worse of all situations. You see, most investors can usually absorb and discount information rapidly whether good or bad, but what they can’t abide is not knowing. My momentum indicators certainly told me the market was heading lower (and then higher) depending on the most recent news but it was technical analysis that gave me sign posts along the way. Was it perfect, heck no, but it was better than staring down into a great big black abyss and wringing my hands.
As 2008 approached and the unknown loomed larger, I expect an increasing number of investors, both professionals and traders, began to look at technical supports, resistance, and pivot points. Like me, they began to trade or invest according to those indicators. This creates a domino effect. The more people are acting in concert to buy or sell a stock, a market, the dollar, gold, silver or oil, the more the outcome will be as expected. But don’t take my word for it. In my next column we will hear from one of the most important technical analysts on Wall Street today. He will tell us how he does it and may even give us his view of the markets in the months ahead. Stay tuned.