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Technical Analysis Vs Stocks...is There A Connection?

Jul 16, 2008
To determine what worldwide stock markets will do as far as fluctuations in price, involves first determining which school of thought will be utilized regarding the analysis of companies and the investment prospects they pursue. The most widely used school of thought which has proven reliable over multiple decades is the school of fundamental analysis.

The school of fundamental analysis looks at the companies financial prospects, whether the desired results are achieved, and how it stacks up to the competition. Alternately, technical analysis has been used due to its success even though it is primarily unscientific. Well, what's the connection regarding both stocks and technical analysis?

Technical analysis is the study of past market trends to help forecast what future stock prices will be. However, this doesn't explain the entire connection between technical analysis and stocks. Needless to say, what makes people conclude that the price of a stock is determined by looking at just data and not take into consideration of the overall condition or financial state of a company?

Well, part of the reason that technical analysis is utilized by some market analysts is that, although one would think that statistically speaking a trading day on the stock market should only be influenced by that day's events and treated like an independent event, the reality is that most market movement trends over time and the full impact of one event (a downgrade of the stock by an analyst or a movement of earnings higher than expected by the same analysts) is never isolated to one day.

As a result, technical analysis utilizes tons of data including old stock quotes, trading volume charts, and a host of other data, to develop charts and graphs that work to determine exactly how long the impact of a move in a company will persist and impact the stock market trading of a particular issue.

In many cases, a side by side comparison of a fundamental analysis and a technical analysis of the same stock market issue have yielded results in which the technical analysis has been more able to predict the short term ebbs and flows of a particular company. However, the fundamental analysis works on a longer term basis, and so the technical analyst has earned a reputation of being a \"short\" predictor rather than a \"long\" predictor in the markets.

Technical analysis is much more difficult to explain to the layperson due to the incessantly large amount of jargon involved, much of it to describe shapes in graphs and trend lines that exist. An elbow, or a shoulder, or a host of other terms can all be used to describe the same trend in a graph (in this case, a level market, followed by a steep drop, and another leveling off) which can confuse and put off the typical investor from investing in a company.

Ultimately, many in the investment community are still asking the question \"What basis can we make the connection between technical analysis and stocks?\" in terms of how that type of analysis can be instituted for everyday use. The reality is, technical analysis is imprecise, open to wild interpretation in some cases, and ultimately serves the purposes of the people that use it. However, given the level of success with the tool, it's unarguable that technical analysis can be a legitimate market analysis tool.
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