The Philosophy of Technical Analysis Pt 2.

Let’s get back into it ūüôā

Technical vs. Fundamental Forecasting

Most traders like to classify themselves as either being on Team Technicians or Team Fundamentalists. Both work to determine the direction prices are likely to move. They just approach the problem from different directions.

D: Uh, what are the differences between technicians and fundamentalists again? Who should I hate?

The fundamentalist studies the cause of market movement, while the technician studies the effect.

D: Wait…I thought the “fundamentals” meant relaxing crazy stalking powers.

It’s true in the sense that you don’t need to be a crazy stalker like was described before. However, a fundamentalist focuses on the overall economic forces of supply and demand that cause prices to move high, lower or stay the same. They look at relevant factors that affect the price of the market to determine the intrinsic value of that market.

That intrinsic value is what fundamentalists use to then gauge if the market price is over or under priced.

giphy (5).gif

Once again, a technical analyst¬†just concentrates on the study of market action. The effect is all she cares about. Causes and reasons aren’t necessary.

D:¬†Okay. Technical analysts just don’t care about what other people think.¬†

In reality, there is a lot of overlap. Many fundamentalists have a working knowledge of the basic tenets of chart analysis. Many technicians have at least a passing awareness of fundamentals.

D: So why Team Technicians over Team Fundamentalist? Fundamental analysis sounds logical as well. Why can’t I do both (because you know…all of a sudden I’m an overachiever.)

The problem is that the charts and fundamentals are often in conflict with each other. Usually, at the beginning of important market moves, fundamentals do not explain or support what the market seems to be doing. It is at these critical times in the trend that these two approaches seem to differ the most. Usually, they do come back into sync at some point, but often too late for the trader to act.

One explanation for these seeming discrepancies is that market price tends to lead the known fundamentals. Stated another way, market price acts as a leading indicator of the fundamentals or the conventional wisdom of the moment.

While the known fundamentals have already been discounted and are already “in the market,” prices are now reacting to the unknown fundamentals. Some of the most dramatic bull and bear markets in history have begun with little or no perceived change in the fundamentals. By the time those changes became known, the new trend was well underway.

After a while, the technician develops increased confidence in her ability to read the charts. The technician learns to be comfortable in a situation where market movement disagrees with the so-called conventional wisdom. A technician begins to enjoy being in the minority. She knows that eventually, the reasons for market action will become common knowledge. It is just that the technician isn’t willing to wait for that added confirmation.

giphy (6).gif

In accepting the premises of technical analysis, one can see why Team Technicians believe their approach is better. Because remember, the technical approach includes the fundamentals. If the fundamentals are reflected in market price, then why study the ever-changing levers. Chart reading becomes a shortcut form of fundamental analysis. The reverse, however, is not true.



The Philosophy of Technical Analysis

The first topic I want to learn about is stock investments. Why? Because


I wish I could say I remember everything from the finance class I took in college (sorry Dad), but I don’t. And I probably should start with a basic refresh course…but I have this pretty hefty book that’s been sitting on my shelf, taunting me for a year now. I just want to get started rather than continuing to worry about the proper way learning it. So…

giphy (2).gif

What is Technical Analysis?

Techincal analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends. 

D: Okay cool. What is market action again?

Market Action has 3 sources of information available for us to utilize.

  1. Price
  2. Volume
  3. Open Interest (used only in futures and options).

D-:¬†I guess “price action” and “market action” are used interchangeably.

Philosophy of Technical Analysis

Before getting into the nitty gritty, it’s important to know the 3 premises technical analysis operates on.

  1. Market action discounts everything.
  2. Prices move in trends.
  3. History repeats itself.

D: Okay. I definitely recognize these words…and I definitely know what #3 means. But I really have no idea what this actually means.¬†

Let’s break it down.

Market Action Discounts Everything

Apparently, this is the holy grail of technical analysis. So this is kind of a big deal.

“The technician believes that anything that can possibly affect the price – fundamentally, politically, psychologically, or otherwise¬†– is actually reflected in the price of that market. It follows, therefore, that a study of price action is all that is required. While this claim may seem presumptuous, it is hard to disagree with if one takes the time to consider its true meaning.” -John Murphy

D: That is pretty presumptuous John. I thought I was supposed to be glued to my phone, watching the markets, analyzing the company’s fundamental business structure and following what that company is doing every single second like a complete stalker. What are you telling me?

giphy (3).gif

All John is saying is that Price Action (reminder: price, volume and open interest) should reflect shifts in supply and demand.

  • Demand > supply->Prices should rise. Bullish.
  • Supply > demand-> Prices should fall. Bearish.

So a technician works backward and concludes:

  • If the prices are rising (who knows why specifically…and John really doesn’t care), demands must be exceeding supply. Thus, the fundamentals are bullish.¬†
  • If the prices are falling, the fundamentals must be bearish.

D: Side bar. Bullish. Bearish. What do those terms mean?


  • Bullish Market: When investors think stock prices will increase over time.
  • Bearish Market: When investors think stock prices will decrease over time.¬†
  • Fearless Girl: Every girl’s hopes and ambitions.¬†

John at the end of the day only cares about fundamentals. The fundamentals of supply and demand cause bull and bear markets. All charts created only reflect the bullish or bearish psychology of the marketplace. He doesn’t concern himself as to why prices rise or fall. If everything that affects market price is ultimately reflected in market price, then the study of the market price is all that is needed. So all a technician really does is look at the points on the price chart and lets the market say which way it most likely will go. Sure there are reasons why the markets are going up and down. But she doesn’t believe it’s necessary knowing those reasons in the forecasting process.¬†

Prices Move in Trends

Trends are pretty essential to technical analysis. If you can’t accept that¬†markets trend, then this approach probably isn’t for you.¬†

D: Okay…this makes me feel better that I’m not just gambling away my measly amount of money. There may be some logic to it.¬†

The whole purpose of charting price actions of a market is to help identify trends in the early stages of their development for the purpose of trading in the direction of those trends.

“A trend in motion is more likely to continue than to reverse.” -John’s adaptation of Newton’s First Law of Motion

Another way he looks at this is that a trend in motion will continue in the same direction until it reverses. 

D: Mhmm. Those last 3 words are concerning.

The entire trend-following approach is predicated on riding an existing trend until it shows signs of reversing.

D: Fine. Ride the wave as much as possible and when you start seeing that it’s reversing…ride that wave.¬†

History Repeats Itself

Much of the body of technical analysis and the study of market action has to do with the study of human psychology. Chart patterns tell a story of the bullish or bearish psychology of the market. Since those patterns have worked well in the past, it is assumed they will work well in the future. Human psychology doesn’t tend to change. History is doomed to repeat itself.¬†


That’s all for now.

If you want to do your own reading, all of this is coming from John Murphy’s “Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications”.

And here is a picture of John looking so cute.