There are several methods used by investors and professional money managers to construct their investment portfolios. It is also fair to say that most people do not employ one method exclusively, preferring to get a check from another discipline to verify their conclusions. The secret is to find where one's own style and comfort level.
The study of earnings, revenues, business pipelines and strategies—is the predominant method used to analyse stocks. The theory is that the analyst can find a valuation for the company and thereby determine if the shares are under- or overvalued. From there, the buy, sell or hold recommendation is made.
Some may also group economic and quantitative analysis together with fundamental analysis. In both economic and fundamental analysis there is a large degree of forecasting of the data used to create the stock forecast. In other words, next year's earnings and the current quarter's economic report are both best guesses. How many times do we see an economic report revised later—well after any investment decision based on it has been made?
It focuses on how stock prices are moving and how powerful those moves are. By analysing these two simple data sets—price and volume—it creates derivative measures, such as momentum, and all of it is used to ultimately measure supply and demand.
These are the forces that really move markets and not analyst estimates or government reports. If nobody demands what is being supplied, no matter how great the fundamentals look, then prices are not going to go up.
Supply and demand. These are the forces that really move markets and not analyst estimates or government reports.
These are not mysterious concepts and certainly not what some paint technical analysis to be. All we want to do is figure out where the market is going, hop on board for the ride and then hopefully recognize when the market is changing its mind in time for us to hop back off.
What does technical analysis do for me?
The answer is that the ability to recognize when a stock has reached a support or resistance level, or a shift in perceptions takes place, can help investors know whether to use the:
buy low, sell high approach, or
buy high, sell higher approach, or
whether to buy the stock at all.
The ability to apply this one aspect of chart reading will reveal the market to investors with the same impact as understanding the colours of a traffic light. Once you know that green means go and red means stop, you will know when it is safe to buy or not.
In recent years, two related fields—behavioural analysis and socionomics—have gained followings. Both analyse market action with quantifiable actions of people and add great insights.
Behavioural finance studies how people act when money is at stake.
Socionomics looks at the social mood in society and relates it back to what the stock market is doing.