Technical analysis has been used by beginner investors as well as sophisticated investors for decades in an effort to get the highest possible returns from investments.
While technical analysis is typically used successfully to evaluate investment opportunities by using statistical data and trends of variables in the stock market, there are some downsides that are not usually mentioned by investors and economists alike.
In this article, we will explain what technical analysis is, the benefits you can get from it, and the downsides of technical analysis that are overlooked. In this effort we will help answer is technical analysis worth it for the typical investor.
Technical analysis vs. fundamental analysis
Before you learn about technical analysis, it’s important to understand what fundamental analysis is first.
Fundamental analysis uses practical results to evaluate an investment opportunity, such as earnings, revenue, and the profit or loss of the company.
Other economic factors that come into play with fundamental analysis include macroeconomic factors like the current condition of the economy as well as the condition of the industry that the business operates in.
In addition to these macroeconomic factors, fundamental analysis can also look at the effectiveness of the executive team of the company as well as geographic factors of the business that can come into play.
In contrast, technical analysis for investment opportunities focuses on the study of price, volume, and supply and demand trends for a security.
While technical analysis is typically used for evaluating investments in the stock market, it can also be used for futures, commodities, fixed-income, currency, and options trading.
Technical analysis also differs from fundamental analysis because it assumes that past actions and pricing changes of investments is a future indicator of price movements, while fundamental analysis does the opposite.
Pros of technical analysis
While there are many positive aspects of technical analysis, we’ve identified the top 4 reasons that technical analysis can be beneficial to your investing strategy:
- It’s inexpensive
- It takes less time
- History tends to repeat itself
- Technical analysis can be applied to virtually any trading instrument
Inexpensive
Technical analysis tools are very inexpensive and the software can be very effective being managed by only one person.
This also means that the barriers to entry into the field of technical analysis are also very low and beginner investors can begin to use some of the advanced strategies and tools that sophisticated investors use when making their investment decisions.
Takes less time
Proponents of technical analysis believe that all the information that is needed to evaluate an investment is already priced into the markets and the charts that they analyze.
By having expertise and sticking to studying just the charts and data that are readily available, less time will be spent on studying irrelevant information and more time will be spent on becoming familiar with price movements of the market that is in question.
History tends to repeat itself
As we mentioned previously, a core concept of technical analysis is that it is based on uncovering common patterns in investment trends that you can use to your advantage.
Technical analysts abide by the principle that history and pricing data tends to repeat themselves, which means that studying these trends will allow you to predict future price movements and give you an advantage over other investors.
It can be used for virtually any trading instrument
Technical analysis is so diverse and encompassing that it can be used to analyze virtually any type of trading instrument. It can be used for interest rates, options trading, covered calls, forex, commodities, and more.
You can also implement your technical analysis strategies for a short-term or long-term time frame as well. Intra-day trends as well as yearly trends can be understood through technical analysis.
Cons of technical analysis
While there are many positive aspects of technical analysis, there are also some shortcomings that you should be aware of. They include:
- Steep learning curve
- Conflicting signals
- History may not repeat itself
A steep learning curve
Technical analysis involves many different disciplines including mathematics, economics, statistics, and psychology. Applying your knowledge of all these disciplines into a single field of study can be hard to do for beginners or those that do not have a background in financial analysis. Many traders will take months or years to refine their trading skills.
Conflicting signals
Many indicators in the market can be used by technical analysts to spot specific trading opportunities. Using several different indicators can sometimes yield conflicting signals through technical analysis. This puts the investor in a tough spot that leads to speculation on the direction to take with their investment strategy.
Another strong argument against using technical analysis is because things such as earnings reports and other financial data can change the technical data significantly in a short amount of time. This means that any prior analysis would be wrong and unable to be relied on moving forward.
History may not repeat itself
While some may stress that history does repeat itself when it comes to investments, there is also a strong argument that history doesn’t repeat itself perfectly and therefore technical analysis is not a good indicator in the future movement of an investment opportunity.
The Bottom Line
There is no easy answer to if technical analysis is worth it. While technical analysis is the preferred method of evaluating financial decisions for some, there are plenty of disadvantages that should be considered before deciding on a strategy to implement. It’s important to consider the steep learning curve, conflicting signals, and the fact that history doesn’t always repeat itself perfectly.
The bottom line is that trading using technical analysis strategies can be very useful in some cases, but will take time to learn well enough that you can use it reliably in your investing strategy.
Do I think technical analysis is worth it? I lean on the side of not thinking it is worth it. I have found that some options traders really get bogged down in the details that turns an easy trade into a very difficult one. I prefer fundamental analysis. If you would like to learn more of how I choose stocks then take a look at my post where I share how I pick dividend stocks.
Quickly Find Good Dividend Paying Stocks
Please provide some comments on what you think? I would love to start a discussion on this!
Jim
Sources referenced:
Fundamental Analysis Definition.
Technical Analysis Strategies for Beginners
Technical Analysis Definition.
Trading Analysis and Technical Charts | City Index UK
Top 4 Benefits of Technical Analysis – Financial Web.