THE COMFORTING WORLD OF KNOWING THE REASON
Man is a creature of reason. Our rational minds demand that we know the reason for doing something- whatever be the action. We must know it. Others must know it too so that they can see that we are doing the ‘right ‘thing- the most logical thing. Else they may brand you a maverick- someone given to doing his own thing- and something that goes against the understanding of then majority. This is too much pressure for most people and they generally succumb to the wishes of the majority and toe the line. This is seen in every walk of life. Hence it is no mystery to see that it is followed in the markets as well.
I am referring here specifically to the tendency of most people to have faith in fundamental analysis even though they know nothing about it (except perhaps some jargon). It is, however, not so difficult to understand this behavior, considering that FA appeals to the rational side of the mind and hence seems so much more comforting. The human brain is a glutton for information and revels in processing information in a logical, leading-to-conclusion kind of way. FA gives it that liberty. Consider this, from a latest development. Sugar companies have been given a price increase in the production of ethanol. Blending of ethanol into petrol is expected to increase to 10%. Ethanol production will permit sugar companies to offset the losses from the sugar business. See? Everything fits neatly into one another, like a jigsaw puzzle. Answer- sugar company stock prices should increase. Armed with that sense of confidence created by logical knowledge, you go in and buy sugar stocks, expecting the price to occur. Whether it happens or not is dependent on scores of other factors but those are (as yet) unknown to you- so you don’t even take them into consideration. You remain content in your ‘fundamental ‘analysis, confident that you have done the right thing.
When it comes to Technical analysis, things don’t seem to fit in so neatly. You were attracted to sugar company stock moves when they blazed last week and start searching for answers. But a TA greets you with a different kind of answer. He says, ‘the charts are showing a consolidation of many months and there is now a breakout with high volumes and rather forceful momentum. In some charts, bullish candle patterns have formed while in others overhead resistances have been crossed. In a few cases, patterns have turned better in the higher time frame charts as well. Collectively, answer is the same- sugar stock prices should rise.
But, even though the TA and FA analysts said more or less the same thing the way they said it is quite different. In the case of FA, it seemed to be in English while in the case of the TA, he appeared to be speaking some sort of foreign language! Instinctively, the human mind tends to accept the understandable and rejects the complicated.
The mind, lulls you into a false sense of complacence this way, making you reject something that tracks the market much close fashion compared to something that tracks events from far away. For a common investor, it is very difficult to know what is the margin at which OMCs are operating on with regard to the premixing of ethanol to petrol. There are too many moving parts. With price of petrol at 80 adding ethanol from C-heavy molasses will create a larger margin as compared to adding it from B-heavy molasses. Also, price of petrol waxing and waning will have a say on how much margin the OMCs make form this addition. Then it depends on production of ethanol by domestic sugar companies themselves. It then moves into how much does this ethanol sales offset the losses from sugar business. And how much do the Omc take up from the sugar mills. See, now it gets more complicated and it is quite unlikely that all these diverse pieces of information shall flow to you in a timely manner. So, is your sense of complacence with knowing the fundamentals really appropriate?
Now check what the technical side does. Depending on how matters flow at the company level (separately for the Omc and sugar companies), their prices will rise or fall, their oscillators will strengthen or fizzle out, their attack on resistance will succeed or fail, their test of supports will work or not, their candle patterns will turn bullish, bearish or flat. All these can help us decide whether one should be targeting sugar stocks or the OMCs!
Now, all these are going to happen whether you as an investor know the reasons behind these events occurring- therein lies the key to the understanding of this matter. That events can occur without our being able to know them in time to do something about them is an aspect of market trading that we need to accept.
Relying purely on fundamental knowledge therefore becomes very difficult the more you engage the market. It is ok for those who are working the market from a distance. This is one of the reasons that FA practitioner advocate longer term investing- because the approach cannot be practiced in the short term. TA, on the other hand, can work thru every time frame- so long as you don’t demand an explanation for every squiggle that occurs in the market. It is only our rational mind that demands this. If you learn to quell that, you will find it a lot easier to accept what the charts are saying and hence be able to understand the technical concepts more easily. With understanding comes acceptance. With acceptance comes practice. And, with practice comes perfection and results.
They say that one needs to know more than one language these days to succeed in the modern world. The same can also be said about the market. FA is one language. To succeed, it would be a lot better if one learned the other language of the market as well- technical analysis.