What You Should Know About Technical Analysis
By Fredrick James
The point of this article is not to decipher or bring to light any kind of new revelations on the subject but rather try and explain the influence it has over the investing community and how you can take advantage of it.
Love it, hate it or use it, the truth is technical analysis is here to stay. It’s a technique used by countless individuals to prognosticate future price direction of the markets. There are millions of studies done on the subject, each coming to a different conclusion.
There’s no better testament of the influence that technical analysis has over the investment community than the fact that just about every platform, be it free or paid for, includes some type of interactive chart of some sort.
You can spend hours plotting channels drawing resistance and support levels, each with its own outcome and indication. Tweak it a bit and you can create what you want to believe will happen.
It’s easy to get carried away and have a little bit of over-analysis come into play as well.
Ever happen to you?
I’m not going to argue over whether it works or the best indicator to use but rather point out that many believe it does. So much so, that many traders and investors have their own theories and techniques they closely guard. You may even be one of them.
Be it simple techniques employing the use of moving averages, relative strength, MACD and oscillators to the more advanced and complicated Fibonacci and Elliot Waves theories. You can pick your poison to your heart’s content.
The thing is this, if you understand basic chart patterns and the basics of many of the techniques already mentioned, you can identify not so much what the market is going to do but rather what a large portion of traders will do.
Let’s back up a moment and review just what exactly it is I mean.
In order to do so we need to discuss in brevity the concept of open markets and some basic economics…
In basic economics we know how supply and demand affects pricing. We all understand that the lower the demand and higher the supply the lower the price of the product will be. Conversely prices rise on low supply and high demand.
Open markets are based on the fact that the price of something is what someone is willing to pay for it. The value is based upon the perception of the consumer. Kind of like the old saying beauty is in the eye of the beholder
If we agree on those basic economic concepts then how is it that a company can be worth say 50 million one day and 40 million the next?
Did all there brick and mortar, stock, employees, good will and products lose that much value over night? How?
Is it truly a question of whether or not the company actually lost physical value or more so one of perceived value and the stock is then adjusted to what the market is willing to pay for it?
Add to that the army of investors selling and taking positions trying to anticipate the market trend in order to capitalize on it, and you get the wild moves we see with certain stocks.
So what is it that these leagues of astute investors are looking at and interpreting in their own way in order to anticipate future stock movement?
Well more than likely some sort of technical analysis. This being the case how can you take advantage of it? Let’s look at the classic chart pattern of a head and shoulders.
First off I’m assuming you know a little about technical analysis and chart patterns. So I’m not going to go into too much detail here other than to explain that this is used as an indicator of a reversal in trend to the downside once price breaks the neckline to the down side. It is a bearish signal.
Will it happen? Your guess is as good as mine unless you have a crystal ball. Which if that is the case I would like you to stop reading and call me immediately so we can corner the market and go live on a 300 foot yacht somewhere tropical with umbrellas in our drinks.
I regress, so here is the point…
There are a bunch of others looking at the same thing, thinking the same thing, and more than likely ready to take some action that will create more demand – altering the market and the price.
By identifying this situation you can profit by anticipating not so much what the market will do but what the players in it will do. There is going to be a substantial amount of investors trying to take advantage of the signal and you can profit by using their very own decision making to your advantage.
The best way to take advantage is by using an option strategy that allows you to play both sides of the fence. We don’t know what is going to happen but we can anticipate that there are many that will identify this pattern and try to take advantage of it – causing the stock to move.
That movement is what we want to have happen and the best part is we don’t care in what direction either. We just want it to move. Add in a spike in volatility, due to increased volume because everyone is jumping on board that sees the pattern, and you have a few of the ingredients you need to be able to capitalize from the situation.
In conclusion, technical analysis is great, great because it helps us as option guys not see which way the market is heading but rather see when the market is going to get overrun with investors disrupting and distorting market pricing and giving us a great opportunity to profit from it. It’s all perception.