Technical Analysis: Building Blocks for a Successful Portfolio

Posted on June 1, 2012 by

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Investing beginners and veterans alike are constantly looking for the best tool to give them that ever-elusive investment edge.

Bollinger Bands, one of many technical indicators.

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Technical Analysis is the practice of using statistical analysis of historical price and volume data to forecast future movements of a security. Technical Analysis is typically employed in market timing, and runs somewhat contrary to the Efficient Market Hypothesis (see Investopedia article here) and Fundamental Analysis.

Even so, Technical Analysis is a popular method used by investors to determine entry and exit points for stock trading. Technical Analysis compares certain historical data with a more current, specific period of time in order to forecast upward or downward movement of a stock’s price. An important assumption for Technical Analysis is the old adage, “history repeats itself,” in that market responses to certain factors will be similar across periods.

In this series of articles, I will describe the most popular technical indicators in detail.

First, though, a word on the merits of Technical Analysis. It is important to note that this approach differs significantly from what is called “Fundamental Analysis”, or analysis based on the merits of the company itself, including revenues, product quality, research and development, and more. Though traditional thought would tell us that it is important to consider Technical Analysis AND Fundamental Analysis together in order to come to an informed decision about a stock, many hardcore Technical Analysts refute this notion, saying that the fundamentals of the company itself, as well as anything else that could affect the company, is already reflected in the stock price (StockCharts.com Chart School, link here).

To proponents of the Fundamental Analysis approach, however, this is a faulty approach. The notion that the price takes into account all of these factors, they say, seems be the very reason that we study and take those factors into account. If the price is made up of certain parts, wouldn’t it make sense to study those parts and thereby understand the whole? Scholars have debated this for some time.

In any event, we will focus on the Technical side in this first round of articles.  We will cover Fundamental Factors later. There are a number of mathematical and statistical resources we use within Technical Analysis, called Technical Indicators, that help us to achieve accurate stock prediction. If Technical Analysis is the toolbox, then the indicators are the tools, and certain tools are used for certain situations. For our purposes, Technical Indicators will be grouped into categories based on similarities in what kind of results they predict (i.e. volatility, price changes, etc.). Thus, without further ado, we hope you enjoy our analysis of the Technical Indicators!

To know values is to know the meaning of the market

– Charles Dow of Dow Jones & Company, considered the “Father of Technical Analysis”

More at http://www.businessinsider.com/10-great-quotes-about-the-market-2011-6?op=1#ixzz1wO48pvqU

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