Warren Buffett discovered one small problem with technical analysis. “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer”.
Needless to say, Warren Buffett has had phenomenal success as an investor, his classic investment style of value investing will be studied for generations and is timeless. But Warren Buffett is before the digital age. Not only does Warren Buffett not use a computer for his investing, but he also does not even use a calculator.
In the digital age of data mining, and studying historic price action, which is technical analysis, is like studying history to determine the future.
As Mark Twain wrote “history doesn’t repeat itself but it often rhymes,” in other words, history doesn’t repeat itself exactly, but many of the same patterns tend to repeat themselves. So, since human behavior influences price movements, then recurring price chart patterns are not unusual. It is no coincidence that technical price support and resistance price levels tend to be near round numbers. So there tends to be a collective behavior when pivotal price points are neared.
What makes technical analysis useful as a predictor of prices is that participants tend to behave in a predictable way when these psychological price levels are breached
What’s more technical analysis becomes an even better predictor of future prices when several metrics are used together.
For example, in technical analysis, a price breakout to the upside typically occurs when price action breaches resistance price level and volume picks up. In this instance, a trader would interpret this as a bullish signal, particularly if trading volumes are more weighted on the buy-side. Likewise, if prices near support then bounce upwards as volume picks up this too would be a bullish signal.
So, for example, in precious metals we see silver trading range-bound with its first support level around 22 USD per troy ounce, then 20 USD per troy ounce with resistance around 25 USD per troy ounce. The random walk of the market is not random, hence the expression prices are range-bound
Technical analysis can be a useful tool in building a position in an asset, where ideally you are aiming to buy near the bottom range
Identifying the bottom of a stock price with technical analysis is better than just taking random trades.
Moreover, technical analysis works better when used together with the fundamentals. Put simply, use fundamental analysis to determine the long-term trajectory of the asset and then deploy technical analysis to determine your entry and exit points to maximize your profits.
Technical analysis is the market’s poker face and the trick is to try and figure out whether the signal is genuine or a bluff, so this is where your fundamentals can also help you
Remember, like all highly competitive games, where the winner takes all, what often gives the master players an edge is in one word, deception. The distance deception in boxing, the honey traps, the immaculate deception in football and so too trading has its deceptions.
So technical analysis together with the fundamentals will help you play the markets and hopefully not get played by the markets.