Does Technical Analysis Beat Fundamental Analysis?

This column is about strategic investing across various asset classes—stocks, commodities, FX— using whatever tools fit best, be those ETFs, futures, or options. Before I give you any more key price levels to watch or short-term trading recommendations, I want to clarify my approach to markets.

Markets shift violently, consolidate for a time, and then shift again. Investment advisors and texts talk about smooth, steady returns, but these are mostly idealized fiction. Whether we like it or not, markets move on extremes of pessimism and optimism. This is why smart traders use both fundamental analysis and technical analysis to time entries and exits across all asset classes. Fundamentals won’t always help you when extreme pessimism (or credit crunch liquidation) is driving prices lower than an asset’s “real” value. And they won’t make you feel better when you sell and the price runs higher parabolically on extreme optimism (or perceived demand shortage). Being able to read the charts and a handful of technical indicators can help you navigate and capitalize on the extremes.

In case you are new to technical analysis, or have heard some confusing things about it, let me clear the air. First, there is some analysis out there of questionable value. I’m not a fan of Elliot waves or Gann cycles or that sort of thing. These might work for some traders, but they are too complicated for me and I’m not about to recommend something so hard to define and track.

In fairness to devotees of those types of analysis, I should add that as an FX trader, I often tell people they can ignore the fundamentals of currency flows because they are equally complex and hard to track and interpret. I say that “price precedes fundamentals” in FX and that a weekly price chart can tell you about a currency pair’s next trend move long before all the economists have figured it out and agree.

The second important point I want to make about technical analysis is that contrary to criticisms that it is “voodoo” compared to fundamental analysis, the tools I use most, such as moving averages, are statistically based. They are representations of past price movement that give traders reference points for two of the most important themes in all of trading, mean reversion and trend.

I know many quantitative options traders who think that chart-reading is astrology. I point out to them that the volatility charts they use to compare relative timeframes of historical and implied standard deviation are just like the price charts I use with moving averages. Both forms of statistical analysis are looking for patterns, trend, and mean-reversion information that will give them an edge in a trade.

In the end, the best way to approach markets is with a balance of simple tools. I look at fundamentals as much as possible, but also know that I can’t possibly grasp all the data, interpret it well, and make my decisions based solely on it. Charts tell you where big money is moving before it gets away from you. As many great and highly successful traders have said, the final judge of value at any given time is price. Learning to catch the trends—or as many as you can—earns you more profits because you will be thinking like an investor-trader at all times. And that means you will be buying more bottoms and selling more tops overall. I’ll give you some of the tools to do that next time.