The Failings Of Technical Fundamental Analysis

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Technical Fundamental Analysis Is Far From Perfect

For a number of years, technical fundamental analysis was considered the only real way to make trading decisions. In the late ‘70s and early ‘80s, technical fundamental analysis was used by only a handful of traders. As difficult as it is to believe now, it wasn't very long ago that most of the financial experts, major funds, and financial institutions thought that technical fundamental analysis was a flawed and nearly useless tool. Now most traders use technical fundamental analysis, and consider technical fundamental analysis flawed.

Technical fundamental analysis is a way of looking at the market that takes into consideration all the variables that could affect the supply and demand of a stock or commodity. The analyst projects what the price will be at some point in the future, using mathematical models that weigh the significance of a variety of factors (including interest rates, balance sheets, earnings projections), and by paying careful attention to the business acumen of the company. The problem with these models is that they rarely factor in other traders as a variable. But it’s people, expressing their beliefs and expectations about the future, that make prices move - not models

The fact that a model makes a logical and reasonable projection based on all the “relevant” variables is worthless if the traders who are responsible for the trading volume are not aware of the model. Many traders – especially those on the floors of the exchanges who can move prices dramatically in one direction or the other – usually don't have the slightest concept of the fundamental supply and demand factors that are supposed to be affecting their prices. And, at any given moment, much of these traders market activity is prompted by a response to emotional factors that are completely outside the parameters of the fundamental model.

Basically, the people who trade (and consequently move prices) don't always act in a rational manner. Ultimately, those who use technical fundamental analysis could find that a prediction about where prices should be at some point in the future is correct. But in the meantime, price movements could be so volatile that it would be very difficult, if not impossible, to stay in a trade long enough to make money.

Today almost all experienced traders use some form of technical fundamental analysis, to help them formulate their trading strategies. Except for some small pockets in the academic community, the “purely” fundamental analyst is virtually extinct. What caused this dramatic shift in perspective?

In one word, money. The problem with making trading decisions from a strictly fundamental perspective is the difficulty of making money consistently using this approach. Technical fundamental analysis creates a gap between what should be and what really is. Analysts are projecting the effects of the variables into the future, and projecting the future prices from that. This gap makes it difficult to make anything but long-term predictions, and these can be difficult for a trader to exploit.

In contrast, technical analysis not only closes this gap, but also makes clear a large number of possibilities for the trader to take advantage of. The technical approach opens up these possibilities by identifying how the same repeatable patterns of behaviour occur in different time-frames — whether by the minute, daily, weekly, yearly, and longer. Technical analysis turns the market into an endless stream of opportunities.

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