Pros and cons of Technical analysis

So after knowing what it is, are we suppose to know how it can help us? well of course.

lets start off from Disadvantages of Technical analysis first.

1. Historical prices

the suggestive trend is based on historical price, which means there is a psychological error here, Representativeness, which is people will tend to evaluate the next move, based on what happened recently. Therefore it might not be accurate, any sudden news can distort the price predicted, or the trend predicted. based on the previous price, it might suggest to us a move the next day, its a short term indication, because its hard to use it as a long term judgement.

2. How much it predict?

like what i said before that, it make use of price movement and volume movement to give us suggestion of the next move. Therefore that is the limitation, we will not know the outlook of the company, its even harder to predict the particular sector. Therefore being useful for tracking stocks, there are still limitation at a bigger picture.

3. the human touch

Part of technical analysis deal with Volume changes, therefore, if the crowd is being affected by certain news, or event, they might overreact, or underreact. Overreact will cause the price to move above or below the fundamental value of the stock price. Underreact will cuase the price to stay stagnant, and not move up or down to the fundamental value of the stock. Example the 2000 tech bubble, valuation of stocks are well over 3000 like yahoo. why? no real reason to explain this, but crowd movement does make a big a difference.

Technical anaylsis look at price consolidation and also price break out point, if an trader do not have adequate education, will the price consolidation = to what others think it is? will one interpret the same as the others?

in an uncertain market like the period where we are all affected by the subprime crisis, prices move a lot more volatile, and based on technical analysis, we might not be able to get into trade.

alright now, lets see some of the advantages. =)

1. Entry point and exit point

Technical analysis actually shows a more specific way of when we can go into the game, and purhcase some stock. If we are educated enough, we will have the ability to interpret the entry and exit point of the stock. It will allow us to maxmize our gain on the stock.

2. Volume trend

It tell us about the traders sentimental, and what is going through the mind of most of the traders, because the market is govern by supply and demand, we will be able to know roughly what other investors are thinking. High demand will push up the prices, and high supply will inverse push down the prices, therefore from there, we can judge how the overall market is working. it also suggest distribution, and accumulation. Together with price, we will be able to identify correction, in which its a more advance way of looking at the prices and volume. It can also help us see a sudden increase of volume, in the intraday chart, to enable us to know if there is a community of buyers having the same sentimental, or institutional ownership, or just simply a damn rich guy.

3. short term market indication

it provide a short term market indication, for example we want to earn a 10% profit of the stock, we can time our entry, and minimize the time usage, (because by buying one security, we are locking in our asset, and not being able to buy others) and getting the goal we want. its more specific.

4.visual indication

there are some chart patterns which are proven that if it happen, a very high chance of a certain pattern will follow after that. As human, we are more visual centered, we like to see more than hear, therefore by looking at diagram, we can actually track down pattern, and aid in our decision making faster. Price pattern also repeat overtime, so if we are going by technical analysis, most likely, we will not be lured to make other decision by the noise made by other investors and expert (noise refer to the senseless and meaningless talk about stocks.)

alright in conclusion, its a powerful and valuable tools, it will be good if its use together with fundamental analysis, just like what William o neil does, we must be open to more methods for our own financial good. =D