Technical Analysis Overview

After a century of use in this country (and 300 years in Japan), technical analysis is more popular than ever. Of course, it's not always called technical analysis. The Visual Investor, I called it visual analysis. That was simply an attempt to get people beyond the intimidating title of technical analysis and to get them to examine this valuable approach more closely. Whatever you want to call it, technical analysis is practiced under many names. A lot of financial organizations employ analysts whose job it is to number-crunch market prices to find stocks or stock groups that are expensive (overbought) or cheap (oversold).

They're called quantitative analysts, but the numbers they crunch are often the same ones the technicians are crunching. The financial press has written about a "new" class of trader called "momentum" players. These traders move funds out of stocks and stock groups that are showing poor momentum and into those that are showing good momentum. They use a technique called relative strength. Of course, we recognize "momentum" and "relative strength" as technical terms.

Then there are the brokerage firms' "fundamental" upgrades and downgrades. Have you noticed how often these "fundamental" changes take place the day after a significant "chart" breakout or breakdown? Economists, who certainly don't consider themselves technical analysts, use charts all the time to measure the direction of inflation, interest rates, and all sorts of economic indicators. And they talk about the "trend" of those charts. Even fundamental tools like the price/earnings ratio have a technical side to them. Anytime you introduce price into the equation, you're moving into the realm of technical analysis. Or when security analysts say the dividend yield of the stock market is too low, aren't they saying prices are too high? Isn't that the same thing as saying a market is overbought?

Finally, there are the academics who have reinvented technical analysis under the new name of Behavioral Finance. For years, the academics espoused the Efficient Market Hypothesis to prove that technical analysis simply didn't work. No less an authority than the Federal Reserve Board has thrown some doubt on those ideas.