Here's an interesting question: If you could look at one and only one source before buying your next stock, which would you choose: a fundamental analyst's report (with no charts in it), or the chart of your choosing? While I like having access to both, I cannot ever imagine buying something without first looking at the chart.
And so we wade into the ongoing battle between technical and fundamental analysts. Frankly, it's one of the sillier debates in investing. But I've heard so many bad arguments and misleading theories about technical analysis that I decided to weigh in.
Before we wade too deeply into the controversy, ask yourself: "Why do I need to choose?" Why wouldn't you use any tool that can be shown to have value? You wouldn't build a house using only a hammer, but no drills or saws. Why limit yourself away from a tool that can assist you as an investor?
I am not a pure technician. I use technicals -- but I also look at fundamentals, sentiment, monetary policy, cycles, trend, quantitative factors, and economic data. I employ every tool I believe can help my investment process, without making it overly complex or confusing. You should, too.
The Basic Theory
There is quite a lot of conjecture about how charts work, but they all boil down to this: The actions of everyone who has done their homework on a stock shows up in the chart.
Let's take the manager of a value fund. This person's methodology relies on fundamentals. He finds a stock he is interested in. His mutual fund has an enormous research budget and tools at its disposal. They put their staff to work, visit the company, speak to senior management, check the channels -- i.e. speak to vendors, suppliers, and customers -- to see how the company's product is selling. After they run through a long checklist, they decide to add the stock to the fund's portfolio.