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Wednesday, July 1, 2009

As an investor can I rely on technical analysis?

ALL the famous investment gurus in the world, like Benjamin Graham and Warren Buffett, say that we should not try to time the stock market because we will not be able to predict its movement.

However, professional technical analysts believe that investors are able to time the market by looking into the historical price trends and trading volumes. They believe that the weakness in fundamental analysis is it is unable to provide the timing to buy or sell stocks.

Fundamental analysts are able to detect good quality stocks for long-term investments. However, they do not know when to accumulate or to dispose the stocks.

Technical analysts believe that a lot of good fundamental factors for certain stocks may have already been reflected in the stock prices. As a result, any investor who would like to purchase the stocks may not be able to make gains as the stock prices have already included the good fundamental factors.

Nevertheless, if investors know technical analysis, they may be able to discover the stocks much earlier than the others. A lot of time, these fundamental factors may not be made known to the public.

However, some investors, who are aware of these fundamental factors, may start accumulating the stocks. Technical analysts believe that these early actions can be detected by looking into charts.

Technical analysis is based on the interaction between the supply and demand for the stocks, which can be caused by the rational and irrational factors.

Technical analysts believe that prices move in trend and can persist for a long time until something happens to the stocks.

Even though technical analysts do not know all the factors that influence the buying or selling of all stocks, they believe that investors are able to know the actual shifts in the supply and demand of stocks by looking into their market price behaviour.

One of the advantages of technical analysis is that it is simple to use. Compared with the fundamental analysis, investors do not need to read financial statements before using technical analysis. Nevertheless, investors are still required to have adequate knowledge on how to interpret various types of charts.

Given that there are many types of charts, investors may get confused as some charts may indicate buying signals while others may indicate selling signals.

Sometimes, when there are too many investors using different types of charts, the effects may be neutralised between each other.

For market efficiency believers, they postulate that it is not possible make any gains by merely looking into stock prices and volumes because they believe that the stock market may have reflected all these factors. They label this phenomenon as weak-form of market efficiency.

In most academic researches on testing weak-form stock market efficiency (testing the market based on stock prices and volumes), they discovered that investors cannot consistently outperform the market.

Fundamental analysts believe that by merely looking into technical charts alone may sometimes cause investors buying into poor fundamental stocks.

However, technical analysts argue that these negative factors can also be detected using charts because poor fundamental stocks will normally face heavy selling by investors.

The technical charts will indicate when the stocks start facing selling pressures and investors need to sell the stocks once the charts indicate the selling signals.

Some investors believe that there may be self-fulfilling prophecy on technical analysis.

When many people are using the same technical chart on one company and the chart shows a buy on the stock, many investors will follow to buy the stocks. These may cause the stock prices to go up and reinforce the idea that the technical rules work.

We believe that investors need to know both fundamentals as well as technical analysis as these two methods can complement each other. Both methods have their strengths and weaknesses.

Sometimes we may want to use fundamentals to identify the stocks for purchase, then, use technical analysis to gauge when to buy the stocks; or we can use technical analysis to select stocks and use fundamentals to confirm the quality of the companies.

In conclusion, as technical analysis requires a lot of subjective judgement and experiences, we believe that investors need to have a proper training in this area. Interested investors are encouraged to read books related to this area to have better understanding.

# Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

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