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Just before we get started I want to introduce you to fundamental analysis. Fundamental analysis concentrates on the forces of supply and demand for a given security. This approach examines all the factors that determine the price of a security and the real value of that security.
This is referred to as the intrinsic value. If the intrinsic value is below the market price then there is an opportunity to buy and if the market is above the intrinsic price then there is an opportunity to sell.
A fundamentalist will often examine the true value of shares in a company based on its assets, earnings, and dividends. Once they have come up with a number they will then determine if the share is undervalued or overvalued.
Another example might be an economist who examines a country’s currency based on all the underlying economic factors and purchasing parity to determine the true value of that currency against another currency.
Once he has come up with his evaluation he can determine if he thinks the currency is undervalued or overvalued against a given currency.
Technical analysis is the study of market action, mainly through the use of charts and indicators to forecast the future price of a security. There are three main points that a technical analyst applies.
A. Market action discounts everything. Regardless of what the fundamentals are saying, the price you see is the price you get.
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B. The price of a given security moves in trends.
C. The historical trend of a security will tend to repeat.
Of all of the above points the most important of them is point A. It is also important for you to understand this point, as it is the basis of our approach to trading.
When you look at the price of any financial instrument as a technical analyst you believe that is the true value of the instrument as the market sees it.
Using a technical approach, you believe that all the factors that effect price, including, fundamental, political and psychological have all been built into the price you see.
All this means is that anything that can effect the price of a security has already been allowed for by the market participants. Technical analysts look at charts the same way a doctor would look at x-rays. They examine the charts for information on the future direction of the markets.
Most traders classify themselves as either Fundamentalists or Technicians. The truth is that there is a lot of common ground between the two and the best approach I have found is to take note of both approaches.
For the purpose of this book we shall concentrate on technical analysis. This is how I approach the market but at the same time I am aware of any big announcements that may be coming out e.g. Interest rate changes.
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