Personal Investor: Does technical analysis really work?
Using candlesticks and death crosses to predict the future may seem like witchcraft but technical analysis works – most of the time, and it should have a place in your portfolio.
Once you strip out those kooky charts, technical analysis basically boils down to predicting the future by studying the past. It’s based on the assumption that most human activity is predictable and the past will likely be repeated. If the price of oil has risen on the eve of a full moon 75 per cent of the time for the past decade, for example, chances are it will rise on the eve of the next full moon.
Technical analysts evaluate securities through statistics generated mostly by market prices and volume over different periods of time. There are several different technical methods and tools to predict market trends, thanks in part to the evolution of computer-assisted techniques.
One example familiar to many is the moving average, which tracks the average price of a security over a specified period of time. The moving average is used to spot trends by flattening out large fluctuations and establish support levels on the lower end and resistance levels on the high end. The skill for the analyst lies in the ability to choose time periods and other criteria to get the most accurate read.
Unlike fundamental analysts, technical analysts do not attempt to quantify a security's intrinsic value. A fundamental analyst studies the actual nature of a security, while a technical analyst is not concerned with such fundamentals as corporate profits, supply and demand or quality of management. The technical analyst believes that sort of information is already priced into the market.
Although technical analysis is right more times than it’s wrong, it’s far from right all the time. There are no technical investing mutual funds and few pure technical portfolios to compare with fundamental or value funds. Most technicians are part of big institutional investment teams that employ a mix of styles to find whatever works best. For the average investor there are plenty of online technical analysis tools that could be part of your portfolio.