Monday, October 18, 2010

Technical Analysis

Technical Analysis
Technical Analysis is essentially the reading and interpreting of past charts for a stock’s price movement. This thought process of picking stocks can be attributed to the gambler’s fallacy. Someone sits down to play roulette and watches as the ball lands on red 7 times. A person that falls prey to the gambler’s fallacy “knows” that the next spin will land on black. However, the odds will stay the same. The next spin will have a 47.36% chance of hitting no matter the previous spin. Past results are not indicative of future results.
People that institute TA into their trading philosophy are essentially gambling with their money and worse the money that they are managing for others. It is absolutely impossible to look at a chart of XYZ Company from the previous week and know which way their price is heading for this week. There is useful information that can be gained by looking at charts, but it will not give you any indication of the future price movement of that stock.
TA can work on a small scale. It works when several investors are looking for an indicator to make a move. They all are using the same software and charts, and they are given a buy signal for a small cap, low volume company. They all simultaneously pounce on their money making opportunity. This will make the demand for this particular company go through the roof. The price will then go up and they will all be patting themselves on the back for their strategy working so well. Then they face the problem of getting rid of this company that they’ve made a return on, but the volume spike it received has returned to normal and there seem to be way more sellers than buyers. UH!! OH!!
That is how TA can work. I, personally, do not consider that a type of trading strategy that I would want to risk my money using. I certainly would not risk the money of investors with this strategy either. I would much prefer to use another method that would be safer and not require me to be a psychic.

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