What Does Technical Analysis Mean to You?
I was having a couple of beers after work the other day with a friend of mine who manages money. This particular market participant earned his Chartered Financial Analyst (CFA) designation and uses fundamental analysis to make buying and selling decisions. The CFA exam is tough, so I have a ton of respect for anyone who has finished the program. I have some friends who have made it through all three tests and unfortunately a few who have not. The CFA exam focuses on Fundamental analysis (although I hear there is a chapter on technicals in the required reading) while the CMT program is about Technical analysis. I went through the Chartered Market Technician program about 5 years ago and would recommend anyone to go for it if you're interested in managing risk in the markets (including stocks, bonds, commodities, & currencies).
The reason that I bring this up is because of the misunderstanding I find out there about technical analysis. My CFA friend mentioned that because he does not understand the concept of Elliott Wave, that he is not a technician. "But what about Sentiment data?", I asked him. He says, "Oh yea I look at that, I think it's important". My friend is a very smart guy and understands the concept that when bullish sentiment, for example, gets to an extreme, it reaches a point that anyone willing to buy has already bought. With no one left to buy, there is only one direction for prices to go. Same thing in extreme selling. By the end of our conversation, he realized that by analyzing sentiment data, he was studying the behavior of the market rather than the goods in which the market deals.
“Technical Analysis refers to the study of the action of the market itself as opposed to the study of the goods in which the market deals”
- Robert D. Edwards and John Magee in 1948
My friend and I order another round and keep the conversation going. He's a market junkie just like me so loves the back and forth. The idea of head and shoulders patterns comes up. He doesn't understand why it's supposed to work and why sometimes it doesn't. I tried to explain how when it doesn't work, it is actually much better. The false move creates a really fast move in the opposite direction where if recognized early can be the best risk/reward trade out there. But this one is a little bit harder to explain I guess, or maybe I didn't do a good enough job at it. Either way, he wasn't interested, so we moved right along.
"Seasonality!", I tell him. He says, "yea, so what?". I get into different times of the year when stocks tend to behave in certain ways. You know, end of the year stuff, January effects, August slow downs because everyone is on vacation, etc etc. And he totally gets it. He not only got it, but tries to use it to his advantage whenever possible. Well guess what my friends, the study of these seasonal changes is not the study of goods in which the market deals, but the study of the behavior of the markets. My buddy is starting to understand.
It's getting late at this point and we need to get back to our lives. It can't just be all markets all the time. We both have wives, and he has kids. Responsibility trumps beers and talking shop. So finally we're waiting for the bill, he reminds me that he isn't looking at charts, so he isn't a technician like me. I think this is the biggest misconception about technical analysis. I quickly explained that all chartists are technicians, but not all technicians are chartists. I think I confused him more than ever with this comment. "But it's the truth', I said.
You see, if you're looking at charts then by definition you are studying the behavior of the markets. But if you're looking at sentiment numbers and seasonality or intermarket analysis, then you're studying the behavior of the markets, but not necessarily doing so through chart work. Therefore you can be a technician without being a chartist. I happen to be both, but not my CFA friend. He hasn't admitted it to me yet, but I think deep down somewhere he knows he's got some technician in him. And there's nothing wrong with that. It's something to be proud of as far as I'm concerned.
My pal Greg Harmon over at Dragonfly Capital has a post up today titled, Understanding Technical Analysis in 500 Words. Greg is actually one of the few who have earned both the CFA and CMT designation. He is a great technician and this is a great post, so check it out.
I hope that I've shed some light on the subject and maybe cleared up some questions about the types of analysis we do as technicians. If you're interested in learning more about the CMT program check out the Market Technicians Association website. I get emails all the time from CMT candidates looking for sponsorship. Once you pass all 3 levels, you still need to be sponsored by 3 current charter holders. If you're in that situation or just curious about process, feel free to reach out to me.
In the meantime, I think Greg Harmon nailed it with his suggested reading:
If you are a bit more open minded study the Masters: Steve Nison’s Japanese Candlestick Charting Techniques, 2nd Edition, Martin Pring’s Technical Analysis Explained, 4th Edition, Robert Prechter’s Elliott Wave Principle, Tenth Edition and the bible of TA, Edwards & Magee’s Technical Analysis of Stock Trends, 9th Edition as a start.
I would add John Murphy's Technical Analysis of the Financial Markets and Intermarket Analysis - two of my favorites. And the first book on the subject that I read after completing the CMT program was my friend Brian Shannon's Technical Analysis Using Multiple Time Frames. Awesome book.
So as technician Martin Pring likes to say,
Good Luck and Good Charting!