There are two schools of thought on price movement and how to predict it. The fundamentalists believe the way to make a successful investment is to concentrate on methods of determining the value of a company. This is done by studying the way that it is managed, the various financial statements emanating from the company, the markets in which its products are being sold, comparisons with other companies operating in the same field, and so on. On the other hand, technical analysts base their predictions on historic price movement, although most of them would agree that there is some value in the fundamental approach. The technical analysts are of the opinion that the positive and negative aspects of a company are reflected in the stock price, and that a lot of unnecessary effort in studying the fundamentals can be avoided if you carry out the correct price analysis.
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The difficulty with the fundamental approach is that the investor might have to wait a long time before realizing a profit. Although you discover that a company is undervalued, and that its stock price ought to be much higher, and until other investors come to the same conclusion, the price cannot expect to move down in the required direction. This composite view of investors towards the company is not being measured by an analysis of the fundamentals. However, technical analysis correctly applied will give a reasonable indication that the weight of outside opinion about the company is either optimistic, pessimistic or neutral. From that knowledge the investor can determine wither to buy, sell, or do nothing. Of course, opinions about a stock, sector, or market can change rapidly, leaving the investor to base his decision on outdated materials. By giving the investor an early warning sign technical analysis is subjected to the severest test.
Some technical analysis methods are far too simplistic. In their most trivial form they come down to a set of rules that should be obeyed without any understanding of the meaning behind them. Typical of such rules are those of the form 'buy when the stock price rises above the x-day moving average' or 'sell when the y-day average falls below the x-day average,' where x and y depend upon which technician you are speaking to. The difficulty with rules such as these is that they may have been formulated for a market quite different from that in which tey are being applied. It is only when the investor starts to ask what lies behind these rules that an understanding begins to develop. This understanding is invaluable in deciding whether or not the current market is the type in which these rules should be applied.
Brian Millard, Channels and Cycles, A Tribute to JM Hurst
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