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Wimberley, TX 78676
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What Is Technical Analysis for Investors?

Books are filled with definitions and interpretations on technical analysis.  A significant part of technical analysis is the art of studying the past, attempting to identify a pattern or event that seems to represent or reflect the market being studied, and then believing that it will work with some certainty in the foreseeable future.

My definition for technical analysis and my adherence to using it comes from a belief that everyone needs something to believe in or rely upon.  I believe in technical analysis because of its close relationship to the supply and demand of the market.  Fundamental analysis, which is by far a more popular method of analysis, is generally flawed in that it does not address the issue of ‘when.’  When should I buy or when should I sell?  Researching the hundreds of different fundamental ratios is the full-time job of thousands of securities analysts.  However, think about this simple fact.  Almost all fundamental ratios involve price.  So why not analyze price?  Most forms of technical analysis do just that.

Is technical analysis the same as market timing?

Sometimes it is, sometimes it isn’t.  Market timing has received a bad rap, especially by those who believe it is a process by some who blindly follow some over-optimized mechanical system without utilizing money management or an asset commitment plan.  In that regard, its bad rap is appropriate.  The analysis of risk and reward is not market timing in the sense that many think of when using that often misused term.  Determining when the market has too much risk is not market timing, but prudent and discretionary investment decision making.  Next time you hear a brokerage firm analyst mention that no one can time the market, or that technical analysis does not work, ask to see his/her record during the bear markets of 2000 – 2002 and 2007 – 2009.  Heck, he/she probably wasn’t a stockbroker then anyway.  I hate it when I call salesmen stockbrokers.  They are not stockbrokers, as that is what the company they work for is called; they are salesmen for a stockbroker.  I feel better now.

Another challenge to technical analysis is that of whether it is an art or a science.  I cannot believe anyone would seriously ask this, and suspect the question comes almost totally from the non-scientific or the innumerate among us.  I do believe that scientists, engineers, and mathematically inclined investors migrate toward technical analysis over time because of its ability to look back in history and see how supply and demand played out.  It is certainly a more analytical approach to market analysis. 

Many claim that technical analysis is science.  My response is that the person making the claim is neither a scientist nor an engineer, and clearly doesn’t know the difference between art and science.  Finance and economics are considered social sciences, which is a wide swath into the wrong direction.  Neither are science, they are arts.  You don’t get a Bachelor of Science degree in them; you get a Bachelor of Arts degree.  Here’s the difference between art and science.  Science is when you can reliably repeat something within predefined parameters.  For example, I know that at sea level, with the ambient temperature at 59 degrees Fahrenheit or 15 degrees Centigrade (59 – 32 = 27. 27 / 9 = 3. 3 x 5 = 15), and the atmospheric pressure is 29.92 inches or 1013 millibars that pure water H2O, in laboratory conditions will boil at 212 degrees Fahrenheit or 100 degrees Centigrade.  I’ll bet a large sum of money on it.  I can’t think of anything in finance, economics, or technical analysis in which I would do that.

Those who get excited and experience a warm feeling about the overused adjectives of quality, strong, healthy, etc. when wall street talks about investing in specific companies are surely the ones who think technical analysis is witchcraft.  Years ago when I used to be entertained by watching Wall Street Week, and was humored by the fundamental analysts who would talk endlessly about how they liked to pick good quality companies and hold onto them.  They then quickly point out the Ibbotson study that shows that equities have performed at about a 9+% annual rate for the last one hundred years.  Hogwash!  While the study is true, it is totally irrelevant as one does not have a one-hundred-year investment horizon, and is therefore not applicable to humans.  Most investors have a good twenty-year period in which to make their serious investments.  There were many, many twenty-year periods in the last one hundred years that resulted in negative or inadequate returns.  The most egregious example is if you had bought in 1929, you did not break even until 1954; twenty-five years later.  And guess what, getting even is not what investing is all about.

A good detective will tell you that some of the least reliable information comes from eyewitnesses. When people observe an event, it seems their background, education, and other influences unrelated to the observed event, color their perception of what occurred.  Most will also be influenced by what they hear from others.  This is also amplified by a number of individual studies done by behavior psychologists.  In a nutshell, they all agree that groups of people will tend to amplify the consensus view rather than challenge it.  A group’s ability to focus on common knowledge and uncover anything new is commonplace.  Plus the fact that if someone in the group is acknowledged as an expert, their opinion can totally dominate the thinking for the group and can lead to what is known as the “herd” mentality.  Talk radio is a perfect example of this.

“The riskiest moment is when you are right.  That’s when you’re in the most trouble, because you tend to overstay the good decisions.”  Peter Bernstein

I don’t want to turn this into a science article, but I am adamant about correcting the proliferation of bad or incorrect information that exists in the financial markets and by showing you similar misconceptions that you may have believed before is the best way to get your attention.  In a previous articles there have been discussions about believable misinformation; if you found that you believed one or more of those misconceptions, then how many market-related ones do you also believe?

Technical analysis will let you deal with reality and keep you from falling victim every time the financial news offers their expert opinion on why the markets did today what they did.  I remember when the Indonesian earthquake tidal waves killed thousands of people, but you could not begin to know how many during the initial broadcasts.  Most news sources were stating guesses anywhere from 15,000 to well over 150,000.  Many news sources cannot even keep the number consistent within their own articles.  Do you think they can also tell you why the markets did what they did on a daily basis?

Stick to technical analysis, it will increase your understanding of the markets, if only by the fact that you are uncovering information about market behavior.

Here are some comments on technical analysis that I read years ago in “The Commodities Futures Game” by Richard Teweles, and believe to be just as valid today: Almost all methods of technical analysis generate useful information, which if used for nothing more than uncovering and organizing facts about market behavior will increase the investor’s understanding of the markets.  The investor is made painfully aware that technical competence does not ensure competent investing.  Speculators who lose money do so not always because of bad analysis, but because of the inability to transform their analysis into sound practice.  Bridging the gap between analysis and action requires overcoming the threat of greed, hope, and fear.

Technical analysis is the art of analysis that will keep your emotions from being a part of your investment decision-making.  While not infallible, it certainly gives you the tools to do so.  It will also assist you in overcoming the human traits of ignorance and bliss.  Ignorance is an intellectual state and appears to be chronic in many people as regards to the stock market.  Bliss is an emotional state and it characterizes many investors as long as the market is going up.

Deluded by emotions, one cannot begin to be successful in the investing arena without some means of controlling greed, fear, and hope. 

Greg Morris (www.StockCharts.com)

Strategic Investing in 2018: using Global & US ETFs and Mutual Funds

Within the global stock market universe, going foward we will be investing mostly in ETFs and traditional mutual funds of assets classes, sectors, and industries within sectors, depending on whether the investments are in a market uptrend (or not):  

  1. Stock ETFs and funds of diversified US and global large / midsize / small companies;
  2. Stock ETFs and funds of US and global "sector and industry-specific" investments;

  3. ETFs and funds of US and global real estate investment trusts (REITs) - for income;

  4. ETFs of “Price-only” global commodities (gold, oil, natural gas, commodities, etc.) 

Regarding income, we may invest similarly in US and global ETFs and funds of bond asset classes and global regions, assuming these income-focused investments are in a bond market uptrend.

When interest rates are one the rise (like now), income investments are not in favor. Its best to wait for aggressive income investing until central banks cease raising rates. 

ORP/TSA 

Related to the above investment plan, in our Fidelity higher education ORP/403b portfolios, we will be using the same strategy. Of course our ORP/403b portfolios are limited to the investment choices allowed by your educational employer. Fortunately, performance wise, employer-specific investment limitations have not curtailed the long-term growth or risk profile of your Fidelity ORP/403b portfolios under our management.

Summary

Finally, in a few of our IRA and brokerage portfolios, we will only be investing in individual stocks that are operating to address or solve an important global issue (to be defined by our research). With the stock markets possibly maturing into the latter stage of this current bull market, individual stocks are becoming more risky and more volatile. 

At this time, we want to limit risk rather than exacerbate risk. Hence, individual stocks are more vulnerable to losses, especially every three months when they report their quarterly earnings.

Understanding How the Stock Markets "Discount Future Growth"

Let me clarify what "how the stock markets discount future growth" means.

Essentially, the phrase means that current price valuations we now see in the global stock markets have already incorporated most of the "good future growth" news they can either imagine or fabricate into future stock prices - something like six months into the future.

Of course there will be some short-term economic or corporate news items that will continue to create "noise" stock price adjustments in the future.

Nevertheless, given that today's stock market prices are probably "fully valued" for the next six months, we need to consider making the following market adjustments as this Update is being written:

1) Systematically reduce the overall portfolio percentages of our current growth investments (that have already done well for us);

2) Prudently rotate some of our 'growth" money into investments that are starting to attract new institutional money.

As needed, we will immediately make investment portfolio adjustments as conditions change.

Please contact me if you have any questions about this Strategy brief - or your current Fidelity portfolios. 

Rocky Boschert

512-751-7363
This email address is being protected from spambots. You need JavaScript enabled to view it. 

Understanding Investment Technical Analysis

What is Technical Analysis?

Technical Analysis is the forecasting of future investment price movements based on an examination of past price movements. Like weather forecasting, investment technical analysis does not result in absolute predictions about the future. Instead, technical analysis can help investors anticipate what is “likely” to happen to prices over time. Technical analysis uses a wide variety of charts that show price over time.

Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of theoretical market supply and demand.

Current price movement (aka “market action”) refers to any combination of what happens between the market open or close, intraday highs and lows, and total trading volume for a given security over a specific time frame.

The quantified time frame can be based on intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data and last a few hours or many years.

At Arrowhead Asset Management, we only watch daily, weekly, and monthly price data for our investment decisions.

Key Assumptions of Technical Analysis

Technical analysis is applicable to an investment where the price is only influenced by the forces of supply (sellers) and demand (buyers). In order to be successful, technical analysis makes three key assumptions about the securities that are being analyzed:

  • High Liquidity - Liquidity essentially means the combined buy and sell volume (# of shares). Heavily-traded stocks allow investors to trade quickly and easily, without dramatically changing the price of the stock.
  • Below Average Fees and Charges - We also only invest in ETFs or other investments that are easily bought or sold and do not have any hidden fees or charges. 

  • No Extreme News - To be sure, technical analysis cannot predict extreme events, including business events such as a company's CEO dying unexpectedly, and political events such as a terrorist act. When the forces of “extreme news” are influencing the price, technicians have to wait patiently until the chart settles down and starts to reflect the “new normal” that results from such news.

The Basis of Technical Analysis

Modern technical analysis works on three quatifiable assumptions:

  • The Price of a Security Accounts for Everything Good and Bad About the Investment
  • Investment Price Movements Are Not Totally Random - They Generally Represent "Factual" Supply and Demand
  • The “What Is Happening" Is More Important than the “Why It's Happening”

Price of a Security Reflects Everything

Technical analysts believe that the current price fully reflects all known information. Because all information is already reflected in the price, it represents the fair value, and should form the basis for analysis.

The market price of an investment reflects the sum knowledge of all participants, including traders, investors, portfolio managers, analysts, market strategist, technical analysts, fundamental analysts and many others.

It would be folly to disagree with the price set by such an impressive array of people with such professional expertise.

Technical analysis utilizes the information captured by the price to interpret what the market is saying with the purpose of forming a view on the future.

Prices Movements are not Totally Random

Most technicians agree that prices are always in a trend. However, most technicians also acknowledge that there are periods when prices do not trend. If prices were always random, it would be extremely difficult to make money using technical analysis.

An investment technician believe that it is possible to identify an investment's trend, invest or trade based on the trend and make money as the trend unfolds.

Because technical analysis can be applied to many different time frames, it is possible to spot both short-term and long-term trends.

"What" is More Important than "Why"

The price of an investment is the end result of the battle between the forces of supply and demand for the company's stock (or the Fund's daily price). The objective of technical analysis is to forecast the direction of the future price. By focusing on price and only price, technical analysis represents a direct approach.

Fundamental analysis is concerned with why the price of an investment is what it is. For technical analysts, the why portion of the equation is too broad and many times the fundamental reasons given are highly suspect.

Technicians believe it is best to concentrate on what the price is and rarely on why the price is where it is. Why did the price go up? It is simple, more buyers (demand) than sellers (supply). After all, the value of any asset is only what someone is willing to pay for it. Who needs to know why?

General Steps to Technical Evaluation

Many market technicians employ a top-down approach that begins with broad-based macro analysis. The larger parts are then broken down to base the final step on a more focused/micro perspective. Such an analysis might involve one, two, or all three steps below:

  1. Broad market analysis through the major indices such as the S&P 500, Dow Industrials, NASDAQ and NYSE Composite.
  2. Sector analysis to identify the strongest and weakest groups within the broader market.
  3. Individual stock analysis to identify the strongest and weakest stocks within select groups.

The beauty of technical analysis lies in its versatility.

Because the principles of technical analysis are universally applicable. It does not matter if the time frame is 2 days or 2 years. It does not matter if it is a stock, and ETF, a market index or commodity. The technical principles of price support, price resistance, price trend, price trading range over time (and other aspects) can be applied to any chart analysis.

Technical analysis is by no means a panacea. But investment success requires serious study, dedication, and an open mind. Technical analysis expertise inceases the success rate substantially.

At Arrowhead Asset Management, we use technical analysis to take major risk out of our investment decisions. And it works 80% to 90% of the time!

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