Technical Analysis

I have a confession to make, I don’t know much about Technical Analysis. Recently I decided to remedy this and bought a highly recommended book. The book is Technical Analysis: The complete resource for financial market technicians by C.D. Kirkpatrick and J.R. Dahlquist. I have just completed a first reading of the book. It is quite interesting although a bit dense at times. However, it is still easy enough for the beginner.

According to the authors Technical Analysis is the study of past market data, mainly price and volume data. This information is then used to make investing or trading decisions. It is based on one major principle: trend. The basic assumptions are:

• Stock prices are determined by the interaction of demand and supply
• Stock prices tend to move in trends
• Shift in demand and supply cause reversals in trends
• These reversals can be detected in charts
• Emotions and investor behavior influence security prices. The two main emotions are fear and greed

The technicians mantra is the trend is your friend. The strategy is to buy a security at the beginning of an uptrend at a low price, ride the trend and sell when the trend ends at a high price. However, implementing this strategy is quite difficult according to the authors.

The chapter on sentiment is quite interesting. Market sentiment refers to the emotions of market participants. For example in a typical bull market, at the peak of the optimism, most investors have put all their available money in the market. Therefore there is no new money available to drive the market higher. The market has therefore peaked and the only way is down. At the height of the emotion, prices deviate substantially from fundamental values, a correction is due.

I think this happened recently in the Nigeria stock exchange (NSE). The NSE All Share Index began to decline (loosing 3% for the year) and the management acted in a bizarre fashion to stop the decline on 9th June. They achieved this by freezing fall in prices for a week. This was a panic reaction and although I gained from it, I sincerely hope NSE management will not do this in the future. This amounts to price fixing and does not bode well for the long term health of the market.

The book is quite a useful addition to Technical Analysis literature. I will recommend it to anyone who is interested in Technical Analysis. I have picked up a few things I will try out but my conclusion is that I simply do not have the time to fully exploit technical analysis. I still have my day job to worry about.