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Investing Strategies - Technical Analysis

The two major approaches to stock picking are analysis of fundamentals, and technical analysys. Technical analysis is concerned primarilyt with finding patterns in the movement of stock prices. The patterns follow from direct, second, and third order effects of human behavior. Technical analysts base their prediction of stock prices on the psychology (such as fear and greed) of the market participants.

While I personally prefer to base my investing on fundamentals, I find it is still important to understand technical analysis in today's market since the price of some stocks bear little resemblance to what one would expect from fundamentals. Technical analysis is also important to understand the second order effects of how the market will react to changes in fundamendtals (i.e. some participants will respond to changes in the fundamentals, and them more market participants will react to the change in price).

In recent markets there are several times when Technical Analysis signals have been particularly difficult to decipher. It is believed that part of the reason is the increase in programmed trading, where trades are decided by computer, and thus divorced from the psychology of the market. In such an environment, the second order effect is based not on psychology, but on how the computers are programmed to react, and most of them have been programmed to understand the principals of technical analysis, though with some of the program having deeper analysis of how the broader market (human participants and other program trading platforms) will react. This means that are a more significant portion of the trades take advantage of first order technical analysis, the stategy becomes less useful to thoes that can not react as quickly or with as deep an analysis.