What Is Technical Analysis?

By Matt Krantz from Investing Online For Dummies, 8th Edition

You can usually spot technical analysts by just looking at their computer screens. Rather than having earnings reports and industry profiles on the display, a technical analyst’s screen is filled with stock charts. If you ask technical analysts what the companies they’ve invested in actually do, they likely won’t know or care. To them, such fundamental details are meaningless because, generally, technical analysts believe

Everything you need to know about a stock is reflected in the stock’s price. In the minds of technical analysts, the buying and selling of stocks yank the prices up and down in patterns that give clues about the future. There’s no sense wasting time reading financial statements, these investors figure, as they’re ancient history in their minds.

Other investors with more experience have already read the reports and made the proper adjustments to the stock price.
Stocks follow predictable patterns. Like astronomers who find patterns of stars in the sky and name them, technical analysts look for patterns in stock price movements. The analysts look at “double-tops,” “head and shoulders,” and other patterns. These chart patterns, if identified early enough, can tip investors off about future price movements. Technical analysts believe this gives them an edge when buying and selling stocks at the right times.
Trends in stock prices continue long enough to profit from. Many technical analysts invest based on momentum. Momentum investors believe short-term price movements tend to continue, and you can make money by piling on. For instance, momentum investors like to find stocks that are soaring and pile in hoping the momentum will keep going. Similarly, momentum investors avoid or short stocks that are falling, betting they’ll only decline more.

When you’re at a dinner party and don’t want to stoke controversy, you probably know to avoid certain topics,such as religion and politics. Believe it or not, technical analysis is a similar lightning rod among investors.

The topic of technical analysis can turn usually cool-headed investment managers red in the face. Fans of technical analysis say everything you need to know about a stock is reflected in its stock chart. Technicians also believe human nature causes investors to follow patterns, which when spotted early, can make them money.

Fundamental analysts, who study financial reports to determine whether a stock is undervalued or overvalued, vehemently disagree. Fundamental analysts believe stock prices aren’t a good measure of a company’s true or intrinsic value. Fundamental analysts think investors can be successful only by studying financial statements and determining how much a company and its stock is worth.

Passive investors, who believe markets correctly price stocks over time, think both technical and fundamental analyses are a waste of time. Passive investors figure it’s practically impossible for investors to consistently beat the market over the long term.

These investors buy passive index mutual funds, hold them, and let other investors lose money buying and selling stocks, usually at the wrong times. Studies have shown passive investors not only save time and effort, but also tend to beat most other approaches.

If you’re new to investing or are a long-term investor, passive investing is likely your best bet. Technical analysis often requires subscribing to expensive websites or installing complicated software on your computer. That’s a lot of work for questionable returns. Most investors will be better off buying index mutual funds or exchange-traded funds (ETFs) and profiting that way.