Technical analysis is one of the two major analytical techniques to analyze financial markets. The second one is fundamental analysis. Fundamental analysis focuses on figuring out the true value of stocks. On the other hand, technical analysis focuses on identifying patterns on a chart to predict future price movements. Do Professional traders use technical analysis?
- Professional traders mix many analysis to acheive profitable trading.
- Technical analysis is very helpful to time and frame investments.
The usefulness of both analysis types has always been a point of debate between traders. Some traders believe that fundamental analysis is best. Others believe that technical analysis is the best way to analyze the financial markets. In this article, we shall discuss both these types and how they work. We’ll also try to answer the frequently asked question that “do professional traders use technical analysis.”
What is technical analysis?
Technical analysis is a systematic way of analyzing and studying financial markets to make informed trading decisions. Technical analysis has been in practice for centuries, however, it has become extremely popular in the 21st century. Nowadays, data science and tools have become more advanced. Today, it is the age of the internet and more people have access to data and advanced tools to make informed trading decisions.
What factors does technical analysis focus on?
Price action is the primary measure that technical analysts consider when conducting TA. They start by observing the charts depicting the security’s price and trading volume. It enables them to analyze past performance and predict future movements. The basic objective of chart observation is to identify trends of the price or volume and how those trends behave over time.
Chart patterns are one of the main helping tools that technical analysts employ. They help analysts to examine and predict how a security or stock has behaved and will trade in the future. The trend line, peak/trough, and moving averages help analysts in this regard.
Volume is another factor used in TA. The volume shows the number of securities or shares traded over a particular period of time. Volume study helps technical analysts to determine the strength of a trend in the market. A bar at the bottom of a chart exhibits the volume.
Trend is one of the most important indicators for technical analysts. They indicate the future performance of stocks or securities.
Momentum is another important measure that shows the speed of price movements of a stock or security. It tracks record of the rate of price increase or decreases over a particular period of time.
Support and resistance
Areas of support and resistance are other important observations that technical analysts make. These help analysts to determine whether a stock is on a bullish or bearish trend.
Moving averages show the average of past movements of a stock or security. These also help analysts to see trends more clearly.
What is fundamental analysis?
The fundamental analysis gives a reasonable estimate of the intrinsic value of a stock. You need to consider both qualitative and quantitative factors to conduct a thorough fundamental analysis.
Qualitative factors are:
- News regarding the company you want to invest in is crucial and can make prices rise or fall. Good and bad news affect supply and demand and finally stock prices.
- Personnel and management changes are equally important as they affect the perception of the market. Such changes directly affect the reputation of a company and ultimately stock prices.
- Economic and financial events are also crucial as they may cause higher volatility and market uncertainty.
Quantitative factors include:
- Earning reports are important as a quantitative factor during fundamental analysis. Traders should track earning reports and releases to keep an eye on changes in the company’s earnings. It is crucial to note whether the stock price reflects the new earning level or not. If it doesn’t, that means the stock price doesn’t reflect true value.
- Balance sheets reflect earning potential of a company and are a good source to judge a company.
- Dividends and other important ratios are also very helpful to analyze a company and its earning potential. As a result, P/E ratio, D/E ratio, ROE, current ratio, earnings yield, relative dividend yield, and price-earnings to growth (PEG) ratio are important figures to look at.
Do professional traders use technical analysis?
Fundamental analysis helps trader screen for great investments
As we have already discussed that a financial market can be analyzed through fundamental and technical analysis. Most traders prefer technical analysis because fundamental analysis has various weaknesses. Accurate market analysis through fundamental analysis may take months if not years before it comes to fruition. Fundamental analysts also believe that stock prices reflect all the fundamental information. In a perfect and ideal market, it should happen but it isn’t always the case. The market isn’t bound to agree with you. The fundamental analysis ends up at an individual’s opinion and an individual’s opinion matters for nothing in the market. Unfortunately, what we think about a stock or security isn’t important. What others think is important.
So, fundamental analysis has certain weaknesses that cannot be ignored. Technical analysis is the second option then and the best one. It allows you to study the way of people’s behavior in the market and that gives you an edge. It enables you to trade what you see rather than making trading decisions based on what you think. The charts and all other indicators will tell everything you need to know. You just have to make informed decisions.
Technical analysis is a wonderful timing approach
So, do professional traders use technical analysis? Yes, professional traders use technical analysis. Studies reflect that most successful traders use technical analysis and rightly so. Jack Schwager’s book “Market Wizards” has several accounts of successful traders who relied on technical analysis. His book verifies the fact that professionals use as well as prefer technical analysis. They all believe that it is the courtesy of technical analysis that has made them so successful.Let us conclude our discussion with a very popular quote of a genius and a very successful trader and investor:
“I always laugh at people who say, “I’ve never met a rich technician.” I love that! It’s such an arrogant, nonsensical response. I used fundamentals for 9 years and got rich as a technician.”Marty Schwartz
Can one use technical analysis?
Now, the question arises that “can one use technical analysis?” The answer is “yes.” Everyone can use technical analysis. However, proper knowledge and training is prerequisite to use technical analysis accurately. Moreover, no matter how good you are at technical analysis, you cannot be a successful trader until you have:
- An effective tried, and tested trading strategy
- Probabilities and risk management
- The correct trading psychology