Five reasons for relying on technical analysis

Summary

  • As compared to fundamental analysis, technical analysis takes quite a few minutes to analyse a price chart for an actionable advice.
  • Technical analysis also helps in short-term trading, down to the time frame of seconds.
  • Doing market breadth studies such as comparing the number of advancing stocks with the number of declining stocks is also helpful.

When it comes to dabbling in the financial markets, there are primarily two forms of approaches, namely: fundamental and technical. While fundamental analysis relies on financial statements of the company, management outlook, industry’s competitiveness, etc. (in the case of equity), technical analysis relies majorly on price and volume of the security. 

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Both forms of analysis have their own pros and cons and an investor is generally inclined towards one of these approaches. However, some analysts use a judicious blend of both approaches to come to a much more refined conclusion. With that being said, let’s look at five reasons that make technical analysis a highly reliable tool.

Read More: Volume; Why It is a Prominent data in Technical Analysis?

  1. Less time consuming

It is quite surprising to see how technical analysis consumes less time despite its good accuracy. While technical analysis takes quite a few minutes to analyse a price chart for an actionable advice (buy/sell), fundamental analysis could take as much as a few weeks to analyse a company to decide on investment decision.  

Even long-term investment decisions using technicals could take a few hours. Also, most often there is an entire team of analysts deployed to gauge fundamentals, which makes it quite expensive than technical analysis.

  1. Aids short-term trading

One of the greatest benefits of technical analysis is it helps to enable short-term trading, down to the time frame of seconds. The best example being high frequency trading, where orders are executed in less than a second and 100s of orders are executed during the day.

This is not possible with fundamental analysis as fundamentals do not change in seconds. Therefore, fundamental analysis is confined to medium- to long-term analysis only, whereas technical analysis works in any time frame.

  1. Standardised analysis

Fundamental analysis may vary from sector to sector. Even different companies within the same sector may require to be analysed with a variation in the core analysis. For eg. when comparing companies based on P/E ratio, investors/analysts should be mindful of sectors such as cyclicals that cannot be analysed using P/E ratio. Further, financial model for every sector, and in many cases every company, is different, thus tedious and time consuming.

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However, in technical, the analysis is quite universal. For e.g., a stock in the financial sector moving up with increasing volume has the same implications as any other stock depicting the same moves, irrespective of its sector. In fact, the exact same analysis also applies to other asset classes such as commodities or currencies, which require an altogether different type of fundamental analysis.

  1. Helps to identify price trend

As technical analysis relies heavily on the price and volume data, it is also able to determine the trend of the security. Knowing the trend beforehand helps to take an informed decision. For example, a stock that is trading above a trendline support has a relatively higher chance to keep moving upwards than a stock that has fallen below its trendline.

As fundamental analysis takes price into consideration only to gauge the value and not the trend, technical analysis is the only option left for an analyst.

Read More: Dow Theory and History of Technical Analysis

  1. Helps to gauge broader market sentiments

Technical analysis is not limited to a specific security but can be applied to an entire universe of stocks/or any other asset class to gauge the overall sentiments in that particular market. For e.g., technical analysis applied on benchmark indices can help gauge the average stock performance of all the stocks in that index (to some extent).

Doing market breadth studies such as comparing the number of advancing stocks with the number of declining stocks is also helpful in determining the underlying strength in the markets.

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