Why Technical Analysis

Fundamental Analysis and Technical Analysis


Every investor needs a method to determine which stock market issues to buy and sell. Generally, there are two schools of thought, Fundamental Analysis and Technical Analysis.


The Fundamental Analyst (FA) believes that corporate value (earnings, growth, and income potential) will eventually be reflected in the share price. If you know what a company is worth, then you can determine what the share price should be.


The FA examines the financial records of the company as well as staying on top of corporate developments.


The optimum situation for the FA is when he finds a company which share price is below what it should be in relation to corporate value. At any given time, the stock price may be higher or lower than is what the current or the future corporate value.


Market pricing is not always or even often efficient.


But eventually, the share price will reflect company value.


However, when the share price is ‘low’, that is when the FA buys the stock. When the share price is ‘high’, that is when it is sold.


Fundamental Analysis maintains that markets may mis-price a security in the short run but that the “correct” price based on corporate value, will eventually be reached.


The Technical Analyst (TA) believes that prices move higher because investors buy shares, and move lower because investors are selling.


Therefore since stock prices are determined by investors, buying or selling for whatever reason, (corporate earnings, economic conditions, or even rumours) then what we should be examining is price action.


The TA looks for the trends of price action to discover if the issue is under accumulation or under distribution.


Further, the TA believes that there is a firm psychological basis to buying and selling which can be seen in looking at ‘patterns’ of stock price movement and that these patterns repeat themselves again and again.


The TA uses various tools to see a smoother and enhanced view of price action in order to eliminate some of the daily volatility which may hide the longer term trend action.


The TA enters the market when an accumulation/buying trend is established and exits when the trend changes to the downside. Technical Analysis maintains that market psychology influences trading in a way that enables predicting when a stock will rise or fall.