3 Reasons Why Technical Analysis Is Superior When Trading Stocks and Options

Here are just 3 reasons why we think technical analysis needs to be incorporate into any trading system or program:

#1 – It’s Based On Statistics

Statistics is a word that sometimes scares people away, but let me be clear…statistics has keep my trading account out of trouble and growing for many years now. Statistics helps us look at historic performance which can indeed help predict future movements (or at least the likelihood of a move). Therefore, it’s imperative that you learn to understand and us it to your advantage.

For our options trading strategieswe constantly look at standard deviations and means to get an idea of how far a stock or ETF is likely to move based on historical price movements. As option sellers we like to make trades with statistical averages of losing money below 5%. This way we know we are trading with the greatest chance or likelihood of making money.

2 - Historical Probability – Not Certainty

Again, we use technical analysis to look back in time and ask “What happened when…” Does this always mean that it will happen again? Of course not – nothing is 100% certain when trading. However, technical analysis of price trends, support/resistance, etc give us general guidelines to where a stock may or may not trade.

For example, if a stock is trading at $20 and has never traded higher than $50 it’s safe to assume that it won’t get there anytime soon right? It could get bought out by another company tomorrow at $50 but this event has a low probablility of happening. Another great use of probability is the Down vs. Up days ratio. The more “down” days this security records, the higher that probability of an “up” day. While this is an elementary example, it illustrates the mechanics that drive technical analysis – probabilities.

#3 – Technicals Deal With Real Money, Not Predictions About Earnings

In short  fundamental analysis attempts to predict the future potential of a stock based on information found in the financial statements, management discussion, as well as other economic and sector information. In our opinion this is all hearsay until it actually happens. Sure a company “could” sell 20% more products next quarter but will it? Technical analysis deals only with where investors are willing to invest – specific price points and volume of transactions. For us, this eliminates any degree of “expectation” or “prediction” in a stock.

If you hear a fundamental analyst say a stock is “worth” $50 but is only trading at $30 then he’s wrong! If the stock was really worth $50 then investors would be willing to pay $50 for it – but they aren’t. They are only willing to pay right now at most $30. Herein is the major difference and advantage to technical analysis over fundamental analysis. Truth in trading versus expectation and prediction.