BALTIMORE (Stockpickr) -- Some people think you can make money by drawing a couple of squiggles on a chart? You've got to be kidding me.
Is technical analysis the Holy Grail for investors? Or is it just tea leaf reading?
It shouldn't come as a surprise that talking about investing strategies brings up strong emotions among their practitioners. After all, people's money is on the line. But few topics draw the same polar degrees of ire and praise that technical analysis does. The thing is, many of the biggest TA critics don't really understand how technicians actually use their toolbox to make money in the markets.
Today, we'll seek to bust technical analysis myths by shining a pragmatic light on this investing discipline.
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Clearly, an exhaustive debate about the usefulness of technical analysis (or fundamental analysis, for that matter) could never be achieved in a single article. That said, I’ll attempt to scratch the surface, debunking some of the more prevalent myths in the technical analysis world.
First, though, let's define exactly what technical analysis is. At its core, technical analysis is the study of the market itself, rather than the goods that trade in the market, in determining the investment-worthiness of a security. While fundamental analysts focus on a company's business to try and get at the share price of its stock, technicians are primarily concerned with price and volume and with the supply and demand factors that actually move shares.
With that definition in mind, let's take a look at some of the biggest myths.
Myth 1: Past Prices Aren't Useful for Predicting Future Prices
One of the most biting criticisms of technical analysis is the idea that there's no way past prices can be a crystal ball for future prices. But that argument is seriously flawed.
Anyone who's ever bought a stock can attest to the psychological impact of watching a position's gains climb or losses mount. It's human nature. That's a good indicator that entry prices do have at least some impact on future behavior. Remember, we judge our performance by comparing a stock's current price against our entry -- and those entry prices are past prices. Because investors' entry prices have a lot to do with their eventual decisions to close their positions (or buy more), it's naive to think that past prices don’t have some impact on how a stock trades in the future.
No, it's not that past prices magically work their way into future prices that's important. Rather, past prices are significant because they are the best way we have to identify pockets of supply and demand in the market.