Complex Made Simple

Technical analysis is a must for investors

Fundamental analysts almost all failed to predict the US stock market crash of 2001 and subsequent recession. But during 2000 nearly all technical indicators were telling investors to sell, hence the value of this approach to stock market analysis.

Having a view on a market, however well informed, is not enough for successful investment. It is the adoption of a sound trading strategy around this view and the monitoring of the investment thereafter that is the real key to keeping losses small and making profits large.

A strategy is just a simple set of parameters that have been determined from the outset, such as when will you get into the market, when will you exit it and where will you place your protective stop loss. Simple matters, in theory: but all too often stop-loss levels are placed too close for volatile markets or investors become lenient with their stop-loss levels hoping for a turn-around.

Knowing when to take profits is also an area fraught with emotion and many investors manage quite easily to turn a winning trade into a loss through poor trade management. One of the best ways for investors to look at the behaviour of markets is through technical analysis.

The vast majority of technical analysis does not rely on the analysis of patterns as many think. The well known patterns such as head-and-shoulders etc. occur very infrequently and trading these patterns when they do occur involves adopting a risk-reward strategy that is very subjective.

Mathematical models

Most technical analysis is quantitative in nature-the use of indicators and studies such as stochastics. These are 100% mathematical models that make no claim to see into the future. They are merely one tool at the trader’s disposal in determining what the market is doing.

Another area is the study of support and resistance levels. No one in the markets would dispute that these levels exist and are based to a very large extent on human psychology.

Any investment strategy – even those based on economic fundamentals – can be enhanced through the use of technical analysis. In essence, there are four ways that an investors can use technical analysis:

1. To decide on the exact timing of trade execution
2. To set stop-loss, take profit levels and option strike rates that take account of levels that are psychologically important to the market
3. Looking objectively for signs of a trend reversal
4. Developing investment strategies that can be back-tested

Most successful technical analysts are equally good at spotting trends and spotting trend reversals. To do this they use a combination of techniques, in a similar way to a pilot using the instrumentation on a plane.

Matthew Clements, editor of the Technical Analyst magazine, says ‘I take every opportunity to highlight the complete failure of fundamental analysts to predict the stockmarket crash of 2001 and subsequent recession in the US. During 2000 nearly all technical indicators were telling investors to sell.’

If you have an interest in learning more about technical analysis and how leading professionals are using it, then the Technical Analyst magazine is hosting a one day forum at the Intercontinental Hotel on September 27th – entitled ‘Technical Analysis in the Commodity and FX Markets’. For more details visit, www.ta-conferences.com.