Technical Analysis focuses on the behavior of the market, states JC Parets of

We try to answer the questions “What?”, “When?”, and “For how long?” Fundamental analysis, on the other hand, concentrates on the reasons that drive the changes in supply and demand, trying to answer the question, “Why?”, if you will. The fundamentalist looks at forces that theoretically drive supply and demand, such as company and economic factors.

Both forms of analysis try to answer the same question: "In which direction is the market heading, higher or lower?" The fundamentalist takes all known information and calculates what he/she considers to be fair value for a security. If prices are below that “fair value”, then the security should be bought. If prices are above that “fair value,” then the security should then be sold.

The problem I have with this approach is that the data that it uses to calculate this “fair value” for a security is removed from the market dynamics themselves: the supply and demand the drives the direction of price. The analyst, therefore, must assume that there is a direct causality between these outside data points and the movements of the market itself. This assumption is an inherent flaw in this forms an analysis. The fundamental analyst first must come up with a forecast for certain events and outcomes to these events, which is an estimate in itself. Then, the fundamental analyst has to come up with a conclusion as to how the market will react to these “forecasted events.” There are multiple steps involved here that are based off an assumption that is clearly false: that specific outside events directly impact the movement of securities. We know that it is supply and demand that drives price. So the number of assumptions taking place in this multi-step process, in my opinion, is a recipe for disaster. Technicians, therefore, are at a huge advantage in that there is just one step involved.

These fundamental factors mentioned above, without questions, play a part in the supply and demand dynamics for a given security. Another inherent problem with this, however, is that there are many other factors involved that determine whether there will be more supply than demand or vice versa. The fundamental analyst must then assume that he or she is factoring only the correct data points in the fair value equation. The problem is that the price of a given market reflects the opinions of all of these analysts but also weighs in the moods of market participants; the fear and greed, if you will. As much fundamental homework that is done to determine a potential fair value, it is mathematically impossible to quantify the additional factors that determine where buyers and sellers will agree on for a security to exchange hands at an agreed upon price.

As technicians, we approach the market knowing, with complete justification, that all known information, including what the fundamental analysts are opining on, is the reason that price is where it is. The market is forward-looking by nature. It is factoring in outcomes for events that have not yet taken place. The market is a smart discounting mechanism and this is why technicians focus on the behavior of the market itself, rather than the forces that may or may not impact it. As a market participant, would you prefer to focus on the cause or the effect? The fundamentalist spends time trying to find the cause, while the technician has the facts and looks for the most probable effect. Technicians do not believe that knowing the cause is necessary for determining the effect.

To put it another way, if price factors in all known information, including everything that fundamental analysts focus on, then by definition, technicians who study price are also factoring in the fundamentals of a given security. If you had to choose one method of analysis, which would it be? Would you be a technician who studies price, or would you go the fundamental route and focus on the causes of movements, blatantly ignoring the only detail that actually pays: price. Remember, fundamental analysis does not take price behavior into account.

"The concept of paying one-hundred-and-something times earnings for any company for me is just anathema. Having said that, at the end of the day, your job is to buy what goes up and to sell what goes down so really who cares about PE’s?” – Paul Tudor Jones

The Benefits of Technical Analysis

One of the biggest advantages of technical analysis is the ability to apply its principles and philosophy to markets of all kinds. Whether a participant is trading stocks, ETFs, Futures, etc, the supply and demand dynamics remain the same. In addition, technicians can focus on all sectors and different types of stocks in each market. With the amount of data that would need to be digested to make fundamental conclusions in a given security, it is impossible for the fundamental analyst to be an expert on all things. Therefore fundamental analysts tend to specialize on a given sector or part of a market. The technician is open to anything and everything that is liquid.

This is where opportunity costs comes into play. If there is a given sector or group of stocks where there is a lack of trend, say Emerging Markets throughout 2011-2014, a fundamental analyst focused on that space is missing out on opportunities elsewhere. As a technician who follows price, these range bound markets lacking a direction in trend are a place to shy away from. During different times of the economic cycle, certain groups of stocks tend to do better than others. There is always a group of stocks where momentum is driving them higher while another group is simultaneously dormant. The ability for a technician to focus his or her attention only on the most actionable markets is a tremendous advantage. The technician is free to pick and choose what countries to be in, what asset classes to be trading, and more specifically how to take advantage of them: through equities, futures, ETFs, or even options for hedging and/or leverage purposes.

Timing-wise, the technician can apply their principles to all time frames. The market is what we call, “Fractal”. Whether we are looking at a chart using weekly timeframes, or a daily chart, or even intraday patterns, the supply and demand dynamics remain the same. As a result, the technician can also apply multiple timeframes to the analysis. The top/down approach looks at a larger time frame, say weekly bar charts, to get a more structural perspective, and then the technician can work down to say a daily bar chart for more tactical execution strategies. There is a common misconception out there that Fundamental Analysis is for the long-term while Technical Analysis is for the short-term. This is a blatant lie. The truth is, the larger the time horizon, the more reliable our technical techniques tend to be.

The shorter the time horizon, the more whipsaws, or ‘failed moves’, we’ll see.

Price leads market fundamentals. The reason is that as a leading indicator and forward-looking mechanism, the market not only prices in all known information, but also factors in unknown fundamentals that have yet to be seen. Some of the most dramatic bull and bear market throughout history began well before any serious changes in fundamentals could be seen. A fundamental thesis may take months or years to play out. As market participants, we do not have the time to let things, “play out”, particularly with the leveraged nature of the futures and forex markets. A 20% drawdown in a position in these markets, while a participants wait for fundamentals to price themselves in, is likely to wipe out the entire account balance for that person before a given thesis plays out fully.

I have found a tremendous amount of value in focusing on Technical Analysis and avoiding the fundamentals completely. I almost feel like the less about the company, the better. I’m human too you know. I have emotions as well. So, the more I can avoid anything that makes me biased towards something, the better off I’ll be. This method may not be right for everyone. But I think we can all agree that Technical Analysis is the most valuable tool we have as market participants.

“Technical Analysis is the most valuable way to look at the market….If what we are principally concerned with is price, then why wouldn’t we start and end with the study of price” – Josh Brown @reformedbroker

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