Abridged article from http://leighdrogen.com/on-technical-analysis/
The technical trader uses technical analysis backed up by fundamentals and a broader macro economic view.
There are no shortcuts when it comes to making money in the market, and technical trading is no different.
Technical Analysis is the study of market psychology
Because people are the ones buying and selling assets in the market, or writing the algorithms which buy and sell assets for them, asset prices will always be subject to the fallibility of human emotions. Because human emotions don’t change, the name of stocks change, the fundamentals of companies change, but human emotions never will, and the chart is the representation of that emotion. So when I look at a chart, and call it technical analysis, what I’m really looking at is the collective psychology of all market participants for that asset.
Patterns in Technical Analysis
The patterns are nothing more than the psychology of the market at work. If you play tennis against a friend over and over, you’ll eventually come to understand patterns in his shot selection. You might decide to position yourself early to take advantage of his shot. Well, we do the same thing in the market. When we see a pattern that we recognize with a high probability of moving in a certain direction, we position ourselves to take advantage of it.
Not Prediction but Probability
I didn’t say I knew where the price was going, I’m saying that I’ve got a rough estimate of the probability of which direction and at what rate the price will move over a certain period of time. I think about the market in terms of risk vs reward, and the patterns that I recognize allow me to only buy or short stocks which give me the best chances of success.
Useful for All kinds of participants - Investors , Traders
Technical analysis is useful on all time frames. If you’re an investor who likes to buy stock in companies where you believe there is good value. There’s this idea in technical analysis called support and resistance. So how can this help you? well, if you’re looking to buy a stock that is at a fair value, it’s best to find a level of support at which the stock has been bought in the past, and set your buy order there.
Technical analysis is about risk management first and foremost. When you’ve got a position that shows you a profit, you can use technical analysis to get you out of the position by using resistance levels and moving averages as well.
A systematic approach for an intermediate term trader
After scanning a universe of stocks for certain fundamental characteristics, I look for relative strength in price and patterns that I recognize on the daily time frame. I like to buy stocks that are trending nicely above their rising 20 and 50 day moving averages.I also use my macro view to weight my portfolio in certain sectors, industries or asset classes. If the market as a whole is not healthy, or showing technical strength, it doesn’t make much sense to be buying any stocks.
It is a business
Over time, just as you would develop a deep understanding for a company’s fundamentals and when you felt it was cheap, you can develop a deep understanding for how the price and volume of a stock or the market as a whole moves. It takes years and years to become comfortable trusting your intuition when you recognize a pattern that has worked for you in the past.