Technical Trading (also known as 'Technical Analysis')
Technical Trading is an investment strategy that attempts to forecast the future direction of prices through the study of past market data, primarily price and volume. Unlike fundamental analysis, which delves into a company's financial health, management, and industry position, technical trading operates on the belief that all this information is already baked into a stock's price. Practitioners, often called 'technicians' or 'chartists', analyze charts and statistical indicators to identify patterns and trends. They believe these historical patterns have a tendency to repeat, offering clues about future price movements. In essence, technical trading is less concerned with a company's value and more concerned with the market's psychology and the supply and demand dynamics reflected in its stock chart. It's a world of trend lines, support levels, and resistance zones, where the chart itself is the primary source of truth.
The Technician's Toolkit
Technicians use a vast array of tools to decipher what they see as the market's language. Their approach is rooted in the idea that price movements are not random but follow identifiable trends and patterns.
Charts Are a Crystal Ball?
For a technician, a price chart is more than just a historical record; it's a map of market sentiment. They believe that collective human emotions like fear and greed manifest in recurring formations on these charts. By learning to spot these patterns, they hope to anticipate what the 'crowd' will do next. Some of the most classic patterns include:
- The head and shoulders pattern, which supposedly signals a trend reversal from bullish to bearish.
- The double top and double bottom, which indicate potential turning points in the market.
- Various triangle patterns (symmetrical, ascending, descending), which can signal either a continuation of the current trend or a reversal.
The core assumption is that these geometric shapes on a chart can predict a stock's future trajectory, independent of the company's actual business performance.
Key Indicators
Beyond chart patterns, technicians rely on a host of mathematical indicators derived from price and volume data. These are typically overlaid on a chart to provide additional 'signals' for buying or selling.
- Moving Averages: These smooth out price data to create a single flowing line, making it easier to identify the underlying trend direction. When a short-term average crosses a long-term average, it can be interpreted as a buy or sell signal.
- Relative Strength Index (RSI): This is a momentum oscillator that measures the speed and change of price movements. It runs on a scale of 0 to 100 and is used to identify 'overbought' (typically above 70) or 'oversold' (typically below 30) conditions.
- Volume: This simply measures the number of shares traded over a period. A price move accompanied by high volume is seen as more significant and powerful than a move on low volume.
A Value Investor's Perspective
From a value investing standpoint, technical trading is viewed with deep skepticism. While both aim for profit, their foundational philosophies are worlds apart.
Focusing on the Shadow, Not the Substance
Legendary investor Benjamin Graham famously drew a distinction between the market's short-term and long-term behavior. “In the short run, the market is a voting machine,” he said, “but in the long run, it is a weighing machine.” Technical analysis is the art of trying to predict the 'votes'—the daily tides of sentiment, rumor, and fear. It focuses on the stock's price, which is merely a reflection of this fleeting popularity contest. A value investor, by contrast, is interested in the 'weight'—the true intrinsic value of the underlying business. We want to know what a company earns, what it owns, and what its future prospects are. Trying to predict price movements by looking at a chart is like trying to understand a business by analyzing its shadow; it can be distracting and, ultimately, misleading.
The Danger of Mistaking Price for Value
The biggest risk of technical trading is that it encourages speculation over investment. It draws your attention away from the fundamental questions that matter: Is this a good business? Is it run by honest and competent people? Is it available at a sensible price that provides a margin of safety? Furthermore, the core premise of technical analysis is challenged by the Efficient Market Hypothesis (EMH), which posits that past price movements cannot be used to predict future prices because all available information is already reflected in the current price. While the market may not be perfectly efficient, relying solely on historical patterns to make investment decisions is a bet against the long-term rationality of the market—a bet that value investors are unwilling to make.
Conclusion: A Tale of Two Philosophies
Ultimately, technical trading and value investing represent two fundamentally different views of the market. Technical trading is a game of predicting price, often with a short-term focus. Value investing is a discipline of calculating business value, always with a long-term horizon. While some may find the patterns and indicators of technical analysis alluring, a true investor understands that lasting wealth is not built on deciphering squiggles on a chart. It is built on owning pieces of wonderful businesses purchased at fair prices. For the patient investor, the most reliable charts are not found on a trading screen, but in a company's long-term record of growing earnings and cash flow.