Technical analysts examine price trends to look to predict future movements in price with stocks. While certain indicators can suggest a move, we need to look at the whole picture.
There are two main types of financial market analysts, and three if we count the quants, although this is actually just a subset of technical analysis, those who base their signals purely on algorithms without the intervention of human judgement.
Quants, or quantitative analysts, can still put together some pretty good trading systems, and the majority of the trading in the stock market is algorithm based, where computers so everything with no oversight. A lot of money is made by these trading systems for some very large institutional investors such as banks.
Classical technical analysis does rely on human analysis to one degree or another, and even those that use a completely rules-based trading strategy will still tweak these rules as the opportunities arise to do so. Most analysts use a more flexible approach though, where judgements are based upon looking at a number of things and then arriving at a conclusion as to the probable direction of a stock or other asset within a given time period.
Fundamental analysts pay little or no attention to price movement and instead seek to calculate things that may end up influencing price in the future, such as a company’s business performance or prospects.
Each approach has its pros and cons. The concept of technical analysis is the sounder approach because it concerns itself with what is actually happening in the market directly, how investors feel about a certain stock and the trends that develop. However, this does take real skill and there is a tendency to just go with what may work but not work all that well, instead of seeking a more optimal approach.
Fundamental analysts confine themselves to a particular type of influencer, which we could call business outlook, but stock prices are affected by more than just these things and the validity of this approach requires that these criteria be aligned with a stock’s performance, and the correlation here is actually a pretty weak one.
This really breaks down when market pressures themselves cause stock prices to move, and in today’s stock market especially, price movements are driven more by the market than anything to do with the stock itself. Fundamental analysis requires that investors not only act upon fundamental data in the manner that the analyst supposes, but also not be influenced by anything else, including market trends. This ends up just providing part of the picture and we cannot faithfully rely on that.
Fundamental analysis can provide us with some useful insights further into the future though, although even these predictions are dependent upon future economic conditions and future trends in investor sentiment. These are the things that move stocks the most and cannot just be left out of our calculations without impacting the validity of our predictions.
At least technical analysts are focused on the right thing, the movement of stock prices if we’re trading stocks, but this focus has to be accurate enough to be reliable. There are so many perspectives and so many different ways to analyze price data that we can easily end up with ideas that don’t work out so well.
One of the real potential issues here that technical analysts face is the tendency to over-rely on indicators.
The goal of any analysis is to predict trends, which is what the fundamental analyst does as well when they perceive business conditions to improve and then assume the stock will move with it.
Predicting Trends Well Requires That We Focus on the Right Things
Technical analysts instead look at how it is moving and use that to predict future movement. We can then take whatever data we have and compare it to other assets to decide where we should have our money.
Relying solely on indicators will always involve a lag of sorts, and this is not something we can avoid, as when we look to reduce the lag, we will get to the point where we’ll get too many signals. If we take a moving average and shorten the periods that are averaged, this can have us trading more often than we may desire.
Lengthening the periods too much will produce too much of a lag, and a good example of this would be with the bear market that we saw to end 2018. We can set the lag so long that the sell signal is produced in December, after all the damage is done, and selling then and either waiting on the sidelines in 2019 or going short then would have both been terrible ideas. This big lag may carry us all the way to the top of this move on the short side, and therefore this would be an extreme example of inefficiency.
Moving averages are only one of the many tools a technical analyst has at his or her disposal though, and indicators themselves are just one tool, with looking at the way that a chart has moved being another important one and perhaps the most important one depending on your strategy and view of all this.
We should always be using both approaches though to some degree or another, and we never just want to look at an indicator without looking at the price action on a chart. In spite of this clear need, we see analysts cite things like popular moving averages all the time, observing that a stock or a market index has crossed a certain moving average like the 200 day, or one average has crossed another, or the slope has changed, and suggesting that this in itself should influence us.
A good example of this in action is with technical analyst Jonathan Krinsky of Bay Crest Partners telling us that the major moving averages with GE are now aligned in such a way that he believes that this is a bullish sign overall.
It is not always enough to look back to when a certain signal has happened before and then study what happens afterward, and then use that as a signal, if Krinsky has actually done this and isn’t just speaking off the cuff here, because there are just so many variables involved and we really need to further refine such an insight or strategy if we can.
GE’s Chart Is Just Not That Exciting Right Now
Just looking at the GE chart should tell us that these signals, be what they may in other cases, are simply noise in this case. Price action, what we see with a price chart itself, tells a bigger story and must always be considered. If the chart doesn’t look bullish, it doesn’t matter what indicator or collection of them say, as stock prices are never influenced by mysterious forces or any force apart from where the price is going.
This is not to say that these indicators aren’t useful, but they are only useful where they add additional information to a price chart to help us decide. If GE was breaking out right now, or actually, when it broke out from its 2 year-long downward trend in December, once the move started to look promising, we might want to look at some indicators to gain some more insight. However, these indicators may have also supported an entry at various points throughout the 2 years, and this in itself doesn’t tell us much if the price action isn’t backing this up.
Looking at GE’s 2019 chart, it is obvious that this stock is now stuck in a sideways pattern. It has moved up a bit in June, and appears to be headed higher, but hasn’t done anything to suggest it’s broke this sideways move and will also be coming up against some resistance soon.
The reason why these indicators may look good is that they take into account the previous bullish move that GE made earlier in the year, but that’s all water under the bridge now. It is not that we don’t want to count that, but we need to count it less than what has happened since the end of February, where it has been more stuck in the mud.
The last 50 days, as reflected in the slope of the 50-day moving average, has been flat since April 12, taking that long to flatten out after the end of the upward move on February 28. This indicator has not moved into bullish territory yet though by any means, and when it does, it will take more than a little move like this to do get the slope of this moving up in a way that could be seen as bullish.
A lot of investors pay attention to the 200 day though, and at the end of February, the 200 did provide resistance and GE bounced right off it and headed downward. This is an example of a good use of the 200, because coming up against this will often give investors pause, although we would want to wait to see if that’s where the end of the road really is, and when we see it is, getting out may be a good move as it was in this case.
The 200 is starting to flatten out a bit now, but this just means that the bear move that came to an end in December is having less of an effect on the average and 2019’s upward trend is starting to kick in more. We need to remember though that we’re talking about data that is all at least 3 months old, and whatever is moving GE’s price has little to do with this long ago really.
Moving averages can be helpful in some cases but they really never can be relied on exclusively, and with this particular stock, these moving averages at least don’t really tell us much at all about where GE may be headed in the coming weeks or longer. Calls to buy it based upon this just aren’t backed by any real substance.
We also can look at what is going on with the company’s fundamentals, and in spite of GE surging pretty well with a new CEO at the helm, there isn’t all that much exciting going on right now, and if there were, this would be reflected in their price trends. Even if we think that a company is moving forward with their business, this only matters to the extent that the market thinks it does, and this is why it makes more sense to watch the market if we’re looking for a price breakout. Other information can tell us that a move may be on the horizon, but the chart really does tell all when it comes to timing stock entries and exits.
Sometimes we can see a meaningful move when a stock’s price breaks away from some of these moving averages, and we’re seeing this now, but this in itself doesn’t necessarily mean anything. This is what our friend is banking on, but once again, we need to consider recent patterns and this looks just like another move within the current range. We need this one to distinguish itself from the other ones that didn’t work, and the moving average data just doesn’t distinguish this in a meaningful way.
At a minimum, we really need to break out of this sideways pattern to move either more to the upside or back down to where this was before its December to February rally. GE has already tested this several times and hasn’t been able to get past it yet, and is getting ready to do it again.
We’ll have to see where that goes and we should remain patient here, and not just jump in without very much to support the idea. Anything that is based upon what happened a few months ago but really isn’t happening now is not relevant enough. That’s what can happen with moving averages though, and while they can help at times, we really need to always be focusing on the bigger picture with these things.