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Investor Toolkit: The trouble with technical analysis—a case in point

technical analysisEvery Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you advice on specific investment topics such as technical analysis. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Technical analysis can be a useful investment tool, but if you rely too heavily on it—or any other single facet of investing—you have little chance of profiting consistently.”

Learning what not to do can be the hardest and costliest part of an investor’s education.

Not long ago I got in a conversation about investing with a 35-year-old engineer. Like a lot of engineers, he was interested in technical analysis—the practice of trying to figure out what a stock or the market will do next by studying trading patterns and history. He asked what I thought of the technical approach.

I told him I was quite interested in that subject when I got my first job in investing, at age 16. But I explained that the more time I spent on technical analysis, the more limited it seemed. I still look at stock price charts every day, and always before buying, selling or recommending any stock. A stock chart carries a lot of information. But I see charts as just one of many things you can use that can give you a little more insight into a stock’s history and outlook.

Focusing on technical analysis in my opinion is sure to lead you to lose money, in the long term if not in the short. But I’d say the same thing about focusing on p/e ratios, or dividend yields, or the number of patents a company owns. You need to look at the overall picture, rather than confine your view to your favourite selection of easily accessible statistical information.

My friend got to reminiscing about his initial experience with technical analysis 15 years earlier, when he first began investing. This was at the tail end of the 1990s stock market boom. As you’d expect with a young engineering graduate, he was particularly keen on tech stocks. He said that he selected his first tech stock buys with the help of technical analysis and some of his trades were extraordinarily successful. He didn’t go into specifics, other than to say he regularly made “multiples” of his initial outlay in a number of these trades.

He winced when I asked if he’d ever heard the expression, “Everybody’s a genius in a bull market.”

To profit consistently, take a broad view of the market and economy

He did confess that his trading had been much less profitable since the tech boom collapsed at the beginning of the 2000s. Now, however, he felt he had a much better grip on the tools of technical analysis. He felt he had it all figured out and that things were going to go much better for him as a result.

When I asked, he had to admit he had had this feeling before—prematurely, it turns out. But he claimed he could see real progress. He was picking more winners, cutting his losses more consistently, taking partial profits, resisting the lure of greed, and generally applying all the little rules that he understands go into the education of a successful trader.

Toward the end of the conversation, he said he felt as if he was at least doing better than many other traders he knows. They have generally lost money overall in their trading careers to date. He, in contrast, is “pretty close to breaking even”, thanks to the sell signals he regularly gets from his charts.

He thought about that for a moment, then said, “I guess I can’t really claim that I’ve been successful. I’ve been saving part of my income and investing every year since I got my first job, and I haven’t made a dime.”

That’s the trouble with zeroing in on any single facet of investing—a trading or investing technique, a particular industry, a single commodity or whatever. With a narrow view, you can get lucky and make a handful of brilliant trades. But to profit consistently in a long investing career, much less make any serious money, you have to take a broad view of the market and economy, you have to learn how to single out stocks that will go up and stay up, and you have to learn to diversify. Many investors are well past age 35 when they make that essential discovery.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow members

Are there any aspects of technical analysis you use to help you make investment decisions? Do you have specific instances in which it has helped you make a good decision on a stock? If a less experienced investor asked you about using technical analysis, what would you tell them?


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