Weekend Sleuth: Does Technical Analysis Really Work?

The Penny Sleuth Features: Penny Stocks, Options and High-Growth Opportunities! Weekend Sleuth: Does Technical Analysis Really Work? By Jonas Elmerraji February 12, 2011 Dear Penny Sleuther, It’s a common question, one that’s probably entered the minds of most investors over the course of the last few years… Does technical analysis really work? When technical analysis first came into prominence nearly a century ago, it was met with some skepticism from traditional, fundamental investors. After all, the idea that you could look at a chart, and glean some sort of predictive ability over a stock sounds more like magic than the conservative financial statement analysis that investors had been used to… And indeed, it is. The biggest challenge to technical analysis over the course of the last several decades has been the misconceptions that surround it. But when you put technical analysis in a more fundamental context, it starts to make sense to even the most conservative investor. Important Upgrades for 2011 — Your 30-Day Retirement Plan One month and just three “flash action” market moves could turn $500 into $4 million or more. It’s happened before — see how millions piled up during 2010. Now the 30-Day Retirement Plan could click again — starting as early as Mon., February 14. You have until tomorrow at midnight to get all of the details… Let’s clear up a few of those misconceptions: 1) Technical Analysis Doesn’t Have Predictive Power Traditional investors have found it tough to come to terms with the idea that technical analysis uses past stock prices to predict where stocks will go in the future. The fact is, it doesn’t. What technicals do is help trader form contingent expectations about a stock based on its price behavior — technicals aren’t infallible, and they’re not right 100% of the time (no investment strategy is, mind you), but when used properly, they consistently provide significant portfolio gains. To be fair, technical and fundamental analysis aren’t mutually exclusive — in fact, they work incredibly well together… 2) Past Prices Actually Can Determine Future Prices You’re probably familiar with the expression “past performance doesn’t guarantee future returns.” While that’s thrown around quite a bit, it’s a phrase that’s completely irrelevant to traders. That’s because studies have shown again and again that in many cases, past performance is highly correlated with future returns. It’s not hard to understand why… Ultimately, stock prices are based on supply and demand in the market. Those prices reflect nearly every piece of fundamental data available (including P/E, dividends, and assets) — but they also include psychological factors that behavioral economists have identified over the years. It’s naive to believe that past prices (like your entry price) don’t impact the future (like your ultimate selling price) — it’s those psychological factors that technical analysis exploits. If anything, 2008 proved that market psychology can cause major divergences in true value and price… Watch the Presentation: Retire with $200? Sounds impossible, but it’s not! This “Secret $200 Retirement Blueprint” shows you step-by-step how to grow a monster-sized nest egg with a little time and a tiny grubstake. Plus, act before the deadline and claim 5 reports absolutely FREE. Click here now to watch the presentation. 3) They Don’t Work Like Fundamentals I once heard about a challenge to chartists — a skeptic offered to pick a random chart, and cut it in half, giving the chartist the first half, and asking him to predict what the second half would show. No one took him up on the challenge. That’s not surprising; that sort of challenge is a bit like giving a fundamental investor a company’s latest earnings press release and asking him to decide if it’s a good investment or not. There are tons of other factors that go into analysis, and there are also tons of other indicators that go into analyzing a stock’s technicals. At the same time, it’d be foolish to assume that a technician can develop expectations for any stock at any time. Quite often, stocks don’t offer a technical indication in either direction — that’s when its best to sit out. Even if the challenges offered by many skeptics are unfair, there is some more appropriate proof that technical analysis works… In recent years, there have been a significant number of academic papers that support the validity of technical analysis. But perhaps more compelling are the successes that investment firms, hedge funds, and technical traders have enjoyed in the last few decades. Today, technical analysis has become a respected discipline with divisions at major financial firms (including Fidelity and Goldman Sachs) dedicated exclusively to technicals. Quantitative and trend trading hedge funds, which use technical factors almost exclusively, have delivered amazing performance too (the best-performing hedge fund in history is a technical-based fund that’s returned 2,478.6% since 1999). And good technical traders have proven that it’s possible to consistently make substantial returns trading the market. The most conclusive evidence, though, may come from personal experience… In the course of my job, I have the opportunity to meet all kinds of successful professional investors and traders at conferences around the country — of all of them I’ve ever met, the only ones who’ve become millionaires from the market (using their own cash, not from management fees) are the technical traders. Exposed! How Wall Street’s Breaking the Rules... Wall Street is secretly breaking the rules, and making a mint! Now you can too — it’s 100% legal — and could have already bagged you $123,850! Skeptical? Curious? Then simply click here right now to find out more. Future Profits from Technology and Small Stocks This week the Penny Sleuth featured ways to profit from technology, the rise of small stocks… and a whole lot more. Here’s a recap of this week’s investment insights… Investing in Tomorrow’s Technology Today — On Monday, Patrick Cox talked about the best way to diversify your technology portfolio. How to Spot the Best Investments of the Next 50 Years — Tuesday, Chris Mayer discussed on of the best ways to flag good investments. Follow Small Stocks Toward Higher Ground — Greg Guenthner joined us on Wednesday to talk about the upward movements of small-cap stocks in the market. Why the S&P Is Headed for 1,400 — On Thursday, I joined you to talk about why I think the market is pointing toward more growth in 2011. Uncover Value Opportunities Using the Price-to-Book Ratio — Yesterday, Jessica Comitto discussed how to interpret P/B ratio and added it your Sleuth stock screen. Comment or question about an article? Just click on any article’s title above and join the conversation by leaving a comment... We’ll be back on next week with more thrilling insights on the on today’s market climate… Until then, please send me any editorial comments or suggestions at editor@pennysleuth.com. Have a good weekend, Jonas Elmerraji Managing Editor, Penny Sleuth P.S.: If you’re new to technical analysis, you still put it to work for your portfolio. My Penny Momentum Trader readers had the chance to capture average annualized gains of 370% last year — and they’ve already had the chance to lock down 5 double-digit gainers in 2011! To join them, all you have to do is click here… Hurry, my next alert hits their email inboxes before noon tomorrow! 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