Technical analysis is covered briefly in financial advisor and broker licensing exams. But understanding the critical role it plays in today’s public markets takes further investigation.
In the past, advisors could get away with dismissing charting as some sort of mystical practice. But it’s becoming more apparent that technical analysis, or the art and science of making investment decisions based on price-chart patterns, is driving markets like never before.
Algorithmic traders, hedge funds and other new players that dominate day-to-day buying and selling activity are employing a heavy dose of price-trend analysis. So, in minding your clients’ assets, you can either get in sync with what those market forces are watching, or you can put your clients at their mercy. You don’t want to be the last one in the know, but the good news is you don’t have to be.
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The Value of Technical Versus Fundamental Analysis
Investors obsess over the actions of the Federal Reserve, earnings and other traditional market buzz. But in today’s new investment reality, analysis of price patterns may have a bigger impact on the future asset-based revenue of your practice than any of those traditional, fundamental analyses.
One reason is that so much money is run based on nonhuman factors. Stock and bond markets now are more like a snowball that gains size and momentum as it rolls downhill. While fundamental value and earnings growth are helpful factors in assessing the risk-versus-reward potential of an investment, that all gets thrown out the window when price momentum takes hold. And that is the case whether stocks are moving up or down.
The Role of Technical Analysis in Client Portfolios
Technical analysis has many valuable uses in the portfolio management process. However, its most distinguished role might be as a risk-management tool. Considering the impact of big losses on a portfolio for a retired client, or one who is nearing retirement, financial advisors can use technical analysis to help avoid major drawdowns. After a client has accumulated most or all of the money needed to retire, one of the few things that can screw it up is their advisor not being prepared to manage risk in the late innings of their savings years.
Historically, it has been easy to dismiss market volatility as a temporary and insignificant factor for so-called long-term investors. However, today’s investor can be less patient than investors of the past. The dot-com bubble of two decades ago produced three down years in a row for the S&P 500. If something like that were to occur again, and in an era of low and rising interest rates, how patient will your clients be? That makes pursuing more than a basic education in technical analysis so important for financial advisors. Even if another decade passes without a significant bear market in stocks or bonds, can you afford not to account for that risk?
Advisors do not have to master technical analysis. But they should understand its growing significance and its potential to help clients make sense of how price patterns and trends impact their wealth. Here are some key takeaways about technical analysis that every advisor should keep in mind.
[READ: How to Explain Stock Market Bubbles to Your Clients.]
Technical analysis is, in part, a self-fulfilling prophesy. Markets have a memory and recognize past levels a stock, exchange-traded fund or interest rate has reached, both on the way up and the way down. With so much money now focused on technical patterns, understanding what those levels are and how to project them forward is a handy skill.
Learning the basics is not difficult, but it takes thousands of hours to develop an expertise that can make or save money while keeping errors in judgment under control.
It’s not just a trading tool. Many investors use charts for short-term trading, even day trading, but technical analysis has tremendous value as an investment decision mechanism, similar to any common fundamental ratio. That said, you need to analyze multiple time frames to fully realize the potential of charting.
Charts of monthly prices can help you grasp a long-term trend and identify potential long-term turning points.
Weekly charts are perhaps the best balance for identifying long-term and short-term patterns.
In today’s more volatile and fast-paced market environment, however, it is an advantage to understand charts of daily and hourly prices, and even shorter time frames.
If you are using technical analysis to make decisions in client portfolios, you might use longer-term charts to identify interesting prospects and use short-term charts to help determine the timing and price of your actual investment decisions.
[Read: Why Financial Advisors Should Watch the Bond Market]
Technical analysis is about price, and price doesn’t lie. Investors can wax poetic about future earnings growth, the impact of an acquisition on a stock’s potential price appreciation and more. That is all speculation.
What is a security truly worth? The price you pay for it. And if you string together a history of actual prices and learn to analyze what those price patterns are telling you about the risk versus reward trade-off, you have something more tangible than any earnings estimate from a sell-side brokerage firm.
The market is always a story, one that technical analysis can interpret. Price-chart analysis helps you listen to the market’s story and apply it for the benefit of your clients. Once you make this part of the regular dialogue with your clients, you might just see doors open for you that never did before.
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Use Technical Analysis to Inform Investing Decisions originally appeared on usnews.com
