The legitimacy of technical analysis is beyond dispute
Traders are looking at what makes money and what doesn’t
THE debate on whether technical analysis is hocus-pocus or not has been replaced with the question: Which type of technical analysis do you employ in your trading?
Central to technical analysis is the assumption that the price of a stock already trades at a level that reflects all the relevant market information, including the company’s performance, the fears and aspirations of investors and possibly even the dealings of insider traders. In today’s markets, where the quantity and speed of information has grown to unmanageable levels, this simplified approach to financial analysis has become a more widely used and accepted form of study.
Take for example the simplest and probably the most commonly used technical indicator: the moving average. It is calculated on various periods of historical price points and overlaid on the price chart, where current price movements are evaluated against the smoothed historical ups and downs. The trader is typically looking for cross-overs where price crosses a short-term moving average, or where a shorter term moving average crosses a longer term moving average. It is a very simple, but very effective way for the trader to be alerted of a potential trade opportunity.
In a recent example, on 6 March the price of Key Energy Services dipped below the 20-day moving average (MA) at $16.48 (point “A”). The 20-day MA next crossed the 50-day MA at $14.96 on 5 April (B), and on Friday the 50-day MA crossed below the 100-day MA at $12.58 (C) – more than a 20 per cent drop in value.
Then there are more sophisticated graphing techniques for the technical analyst, where she looks not only at the change in price, but also on the effect it has on the collective psychology of market participants. Such effects typically manifest as imaginary linear barriers (“support” and “resistance” lines) that could slope upward or downward, suggesting that the peaks or troughs where buyers and sellers exchange roles take place at steadily increasing or decreasing price levels. The theory around this charting technique has developed since the 1930s and it is still very much applied today. Traders look for chart patterns that form between support and resistance levels, like the triangle found on Prudential (below), where price has broken above 755p and is expected to rise to 785p.
Ultimately though, when it comes to trading techniques and methodologies used in the markets, one can be sure that those that do not deliver money-making results quickly fall out of use. Some things don’t change fast – like the fear and greed of humans that trade the markets.
Erik Voges is chief operating officer of Autochartist.