The Value of Technical Analysis
Warren Buffett recently remarked that he does not wish to know the price of the stock prior to his analysis. He would rather do the work and estimate a value for the stock and then compare that to the current offering price. In particular, he opined that knowing the price in advance may influence his analysis. In short, Buffett values the company first before checking against its price to ascertain whether to buy into the company. What about technical analysis? It is using price as a starting point to determine if it is attractive to buy into the company. Hence, technical analysis turns Buffett's consideration on whether to purchase on its head.
Furthermore, does valuation of the company come into the picture of a chartist? Apparently not if you are looking purely at indicators such as moving averages, Japanese candlesticks, momentum etc to make your assessment. By extension, the next question to ask oneself is whether valuations matter?
Graham once famously remarked that the stock market is, if I may paraphrase, a weighting machine in the long run while it is a voting machine in the short run. His profound statement succinctly suggests that the true valuation of a company will shine through only in the longer time frame. It recognizes that the short term fluctuations are dependent on the whims and fancies of the herd who may base their decision on chart patterns or other such indicators. My sense about the value of technical analysis is that it should be looked at as a tool in the broader context of behavioral finance to understand prices in the short term if one wishes to ride its ups and downs.
Technical analysis relies on many assumptions which one may easily poke holes at. For one, it relies on the historical data to predict the future. It requires past prices to be a prologue to the future. In essence, it is driving forward while looking in the rearview mirror. Do you have a stomach for it?