Equity Markets, Valuation, and Analysis

CHAPTER 9Technical Analysis

David Lundgren

Adjunct Professor, Brandeis University

INTRODUCTION

Despite ample academic studies and real-life examples of the efficacy of both the technical and fundamental philosophies of investing, practitioners of each style have historically shown little acknowledgment of each other's process. This unfortunate tension ignores the fact that the two investment approaches share similar philosophical beliefs. Both schools of thought agree that fundamentals are paramount, markets are both efficient in the long term and random in the short term, and behavioral biases are a key determinant in security pricing.

Technical and fundamental investors both recognize that any item whose price is determined by the free-market forces of supply and demand typically trends in the direction of the greater of those two forces. These investors agree that changes in fundamentals are likely to cause changes in supply and demand dynamics, and hence the direction of the trend for a company's share price. Although both types of investors are trying to capture the same fundamentally driven trend change, the fundamental process focuses on forecasting that change, while the technical process instead waits for concrete evidence, in the form of price, that it has indeed changed.

This chapter provides a discussion of the practical application of technical analysis. The following section offers background on technical analysis, including the underappreciated link between the ...