Technical Analysis Question

[rangerdanger12]

I have a quick question about the whole idea of technical analysis and using it in the short term.

A stock price represents the value that people think that a stock has based on its fundamentals and future expected cash flows.

But a technical analyst will look at price and see that since others are selling the stock and forming a downtrend, being short is a good bet. (Over simplifying here)

But if the entire universe of people who participated in the market used technical analysis then would this not detach the value of a stock from fundamentals.

Suppose you created a fictitious ticker that had no connection to any underlying asset, and yet you could trade it.

Suppose you priced this tradable item at $100.00, and it opens on the first day, you have buyers and sellers who are just trying to predict what the next buyer or seller will do. They will draw lines and look for support and resistance.

To these traders it doesnt matter that this ticker means nothing in the real world. Since they are trading off their patterns.

It doesnt matter if appl is at 700.00 or 400.00 to a technical analyst, because the assumption is that the price already represents all the information about its fundamentals. That there are other players who are baking this information into the price. I am using their work to tell me what it should be worth and using my understanding of psychology to make money.

Now if the whole universe traded using technical analysis, the assumption that somebody else out there has already baked the fundamentals into the price would be void. The stock now just trades based on playing a game of hot potato hoping to dump it to the next guy as quick as possible.

It is my theory that the fewer people who use technical analysis the more it will work.

That technical analysts need fundamentalists to tell them what a stock should be worth.

Just random thoughts in my head really all of this and looking for a discussion.

Thanks

 

[Trader333]

It is my theory that the fewer people who use technical analysis the more it will work.

Technical analysis is not a one size fits all approach. There are so many different interpretations which is why some elements of it work some of the time but none of them all the time. People tend to fall into different categories or prefer different approaches and as an example, there are those who like trend trading and those who like range bound trading. The two are not compatible and this is just the tip of the iceberg which is why the market will always accommodate those who follow technical analysis in my view.

 

[rangerdanger12]

Technical analysis is not a one size fits all approach. There are so many different interpretations which is why some elements of it work some of the time but none of them all the time. People tend to fall into different categories or prefer different approaches and as an example, there are those who like trend trading and those who like range bound trading. The two are not compatible and this is just the tip of the iceberg which is why the market will always accommodate those who follow technical analysis in my view.

But I am asking a higher order question. I am not saying that technical analysis doesnt work.

But what I am asking is that if fundamental investors all left the market today all of them, and the only traders left were technical traders, every single trade was done by an algo or human was based of technical patterns or price action.

Suddenly doesnt a stock lose its meaning as a representative value of a piece of a company, since it trades not based on what it derives its value from, the success or failure of a company but simply what others are doing.

For example in our scenario where there are no fundamental investors left, earnings could come out on a stock and they are down, but the stock doesn't move at all since all the technical traders are looking at the chart and its been consolidating in a tight range for a few days and doesn't present a good play.

It doesnt matter what the earnings were, just that others were not paying for the stock because others were not paying for it.

Technical Analysis becomes a game of follow the leader, as the mantra goes, follow the price action the leader. But all we are doing is trying to follow each other. I follow john's trades because he follows tims trades because he follows rose's trades and since rose is selling shares in the market, tim see's this on his chart and then sells, and john starts selling them as well.

No longer does it matter what kind of earnings a stock has.

A follow the leader strategy doesnt work when there is nobody left to follow which are the fundementalists.

Again not arguing just curious

 

[nile_croc]

Being able to spot patterns and determine trends is one thing.......trading them, however, is much, much different.

 

[malaguti]

Technical Analysis becomes a game of follow the leader, as the mantra goes, follow the price action the leader. But all we are doing is trying to follow each other. I follow john's trades because he follows tims trades because he follows rose's trades and since rose is selling shares in the market, tim see's this on his chart and then sells, and john starts selling them as well.

No longer does it matter what kind of earnings a stock has.

But you are presupposing that Tim, Rose and John are all reading the chart in exactly the same way..why cant John, see an uptrend and Tim a downtrend, and Rose ranging? why should they all be following the other just because they are using technical analysis?
Tim may be looking at hourly charts, sees a down trend..John is a much more clever fellow looks at end of day sees an uptrend, and Rosie being a girl cant quite make up her mind.

 

[barjon]

But you are presupposing that Tim, Rose and John are all reading the chart in exactly the same way..why cant John, see an uptrend and Tim a downtrend, and Rose ranging? why should they all be following the other just because they are using technical analysis?
Tim may be looking at hourly charts, sees a down trend..John is a much more clever fellow looks at end of day sees an uptrend, and Rosie being a girl cant quite make up her mind.

aye doesn't have be different time frames either - one person's pullback is the opportunity for trend continuation whilst, for another, it's the start of trend reversal.

 

[Brumby]

I have a quick question about the whole idea of technical analysis and using it in the short term.

A stock price represents the value that people think that a stock has based on its fundamentals and future expected cash flows.

But a technical analyst will look at price and see that since others are selling the stock and forming a downtrend, being short is a good bet. (Over simplifying here)

But if the entire universe of people who participated in the market used technical analysis then would this not detach the value of a stock from fundamentals.

Suppose you created a fictitious ticker that had no connection to any underlying asset, and yet you could trade it.

Suppose you priced this tradable item at $100.00, and it opens on the first day, you have buyers and sellers who are just trying to predict what the next buyer or seller will do. They will draw lines and look for support and resistance.

To these traders it doesnt matter that this ticker means nothing in the real world. Since they are trading off their patterns.

It doesnt matter if appl is at 700.00 or 400.00 to a technical analyst, because the assumption is that the price already represents all the information about its fundamentals. That there are other players who are baking this information into the price. I am using their work to tell me what it should be worth and using my understanding of psychology to make money.

Now if the whole universe traded using technical analysis, the assumption that somebody else out there has already baked the fundamentals into the price would be void. The stock now just trades based on playing a game of hot potato hoping to dump it to the next guy as quick as possible.

It is my theory that the fewer people who use technical analysis the more it will work.

That technical analysts need fundamentalists to tell them what a stock should be worth.

Just random thoughts in my head really all of this and looking for a discussion.

Thanks

This is effectively a false dilemma question. The whole basis of TA is predicated on mass psychology reflecting transactions between interested parties primarily driven by underlying fundamental and business considerations. TA attempts to find the flow of forces between supply and demand and an attempt to position with a greater probability of where the flow is heading. TA will not work effectively when there is absence of demand and supply between fundamental forces. It is the same reason why it is unwise to trade illiquid instruments using TA.

TA is a sub-set of a market which is effectively based off fundamentals as a foundation. If you remove the fundamentals you are effectively removing the market. If there is no market, there is no need of TA because markets are created off fundamentals and not the other way around.

 

[Tradesight]

Ranger,

You pose a very interesting question and perhaps it has already been answered. In your hypothesis you ask how a stock would trade if it had no fundamentals, essentially no real business but rather was a pure "trading vehicle". This sounds an whole lot like a commodity.

A commodity has no true fundamentals, it doesn't earn anything, has no cash flow and is only worth what someone else is willing to pay for it. A barrel of oil will be a barrel of oil in the future, nothing more nothing less.

Probably more than anything else commodities trade very technically. The people who are writing the ticket are generally more market savvy than your typical stock trader. Think of it this way, there are lots of people who are true amateurs who trade stocks for themselves but how may people do you know they buy and sell commodities for themselves? The vast majority of commodity traders are pros and they are all well versed in T/A and that is one of the main reasons that commodities are so volatile.

The other key consideration in your hypothesis is time frames which was mentioned in an earlier post. I'm an ex-institutional trader and time frames matter. If you outsize the market you can't wait to start buying when something gets to an advantageous price b/c there won't be enough liquidity. One has to buy on the way down and get more aggressive as it approaches your price. Scaling-in if you will.

The smaller trader who can take advantage of the shorter term technicals has a real advantage. The smaller trader will also be able to trade the less liquid instruments that a large institution can only play in the investment time frame.

Just my 2c,

Rich

 

[Vicorka]

... It doesnt matter if appl is at 700.00 or 400.00 to a technical analyst, because the assumption is that the price already represents all the information about its fundamentals. That there are other players who are baking this information into the price. I am using their work to tell me what it should be worth and using my understanding of psychology to make money.....

I remember a half of year ago all fundamentalist were screaming that AAPL is the best and most stable stock and it will never crash. Do not understand me wrong, I believe that fundamentals are very important, but it seems to me that you know little to nothing about technical analysis. For a technical analyst It does matter where the AAPL is traded, it is also does matter where it was traded prior do that, it does matter what volume was traded before and what volume is traded now, it does matter how big volume surges (panic selling or greedy buying) are during the price advance and price decline, it does matter how volatile it was before and how volatile it is now and much more. Technical analysis is not just a blind following moving average's pattern, it is more like putting supply/demand flow behind price, volume and volatility action and it works well for those who knows how to use it.

On other hand, if you are professional in fundamental analysis and it brings you money, you should continue using it and do not bother with technical stuff.

 

[Vicorka]

...But what I am asking is that if fundamental investors all left the market today all of them, and the only traders left were technical traders, every single trade was done by an algo or human was based of technical patterns or price action...

Market will be run by speculators, it would become a game of traders against traders, technology against technology, money against money. Market will become extremely volatile. You already saw a shadow of such market in 2008 when big hedge funds were selling short and pushing the stocks lower and lower without paying any attention to fundamentals. They were just interesting n the possibility of making big $$$ in short period of time. If you remember, the government even had to implement some restriction on big short sellers.

So I guess, the answer on your question is that without fundamentals there will be a chaos. yet, without technical there will be a straight line which would move up and down only when actual value of a company was changed. But lucky to everybody we have free market, we have fundamentals and we have technicals and the market balances itself.