Effective investing includes technical analysis

Many investors claim they don’t subscribe to any tenet of technical analysis. Frankly, I have rarely seen a successful investor that doesn’t do a bit of simple technical analysis.

If technical analysis is so terrible, why do so many investors pay attention to the 52 week high or low? Even this thought pattern is a basic form of technical analysis. Basically, you are making a decision based on a past action of the stock. A better name for technical analysis would be chart analysis since it is the use of charts to make investment decisions. It is trying to interpret market psychology based on the past actions of that market. At its core, technical analysis is simply a method of determining if a stock is worth buying or selling.

Technical analysis is simply the study of market generated data. This includes price levels that have served as past turning points, the amounts of stock being bought and sold each day (volume), and the rate of change of price movements (momentum) over a given span of time.

Fundamental analysis, which seeks to uncover the true value of a stock, depends on future sales, earnings, and cost estimates of a company. Often, these numbers change as outside influences, such as the overall economy or the company’s competitive landscape, change. The basics of technical analysis i.e. the price of shares and the volume being sold, never change.

Technical analysis isn’t magic. It won’t guarantee a great buy or a great sell. But chart analysis can help make a decision to buy, sell or hold. These decisions are based on the probabilities of the actions of others. If a pattern on the chart appears, a chart watcher can react to that pattern. It does not work every time, but past performance does give us an idea of what will happen so we can do something about it.

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