Do you know the best ways of using technical analysis for stocks?

Learning what not to do can be the hardest and costliest part of an investor’s education.

Some investors rely on technical analysis for stocks when they’re looking to make investments. Relying on charts seems much simpler than delving into and weighing a company’s fundamentals. But it’s nowhere near as effective.

Technical analysis for stocks—the practice of trying to base investment decisions on past trading and market history

To succeed as an investor, you have to take a broad view in making investment decisions. Technical analysis and other narrow views can sometimes seem to “work” for lengthy periods of time. But they only work a minority of the time, and they never work consistently. Instead, they run hot and cold. As with all random events, their successes occur in bunches.

These bunches of successes come in random lengths, with random beginning and end points. It’s easy to see how this applies with technical analysis, which has an arcane air about it. But the same principle works for something as straightforward and commonsensical as, say, value investing.

Looking at the overall picture

You need to look at the overall picture, rather than confine your view to your favourite selection of easily accessible statistical information. That’s the trouble with zeroing in on any single facet of investing. With a narrow view, you can get lucky and make a handful of brilliant trades. But to profit consistently in a long investing career, much less make any serious money, you have to take a broad view of the market and economy, you have to learn how to single out stocks that will go up and stay up, and you have to learn to diversify.

Many investors are well past age 35 when they make that essential discovery. The key to profiting from technical analysis for stocks is to avoid looking to the pattern on the chart for a prediction of what’s going to happen. Instead, see if the chart seems to support your view of the stock, based on its finances and other fundamentals.

Our advice on using technical analysis for stocks

Use technical analysis for stocks to support—not determine—your view of a company. A far better approach is to look at a chart reading as one tool among many. But don’t look at the chart for a prediction of what’s going to happen. Look to see if the pattern on the chart seems to support your view of the stock, based on its finances and other fundamentals. But remember that the stock market follows a multitude of factors to varying extents, and the most important or influential factors continually change.

It’s encouraging if your analysis and the chart seem to match. But sometimes they don’t. If a company looks promising, but its chart shows a lengthy falling trend, insiders may know something you don’t. That’s when you know you have to dig deeper, and perhaps wait until the situation clarifies itself.

Bonus Tip: Value investing risks and rewards

Value investing fans zero in on financial statistics and ratios as an indicator of what to buy. They like to buy stocks with low ratios of stock price to per-share earnings, cash flow, sales and book value. They assume that if you get enough value in your stock buys, indicated by low numbers in these ratios, your profit is virtually assured, in the long run if not in the short. The problem is that while a 9.0 p/e is attractive, the price can still drop enough to cut the p/e down to, say, 7.0. Then too, a low p/e is no guarantee that the “e” or earnings won’t drop. (When the ‘e’ drops, the p/e automatically shoots back up again.)

In fact, a low p/e and other low readings in value-investor ratios may simply mean that well-informed investors are selling the stock and pushing down the “p” or stock price. If so, it probably means they see flaws in the company’s situation or outlook that investors generally are missing.

We judge the leading Canadian stocks on a multitude of factors, with consistently successful results, as you can see when you take a risk-free introductory subscription to The Successful Investor.

What tools do you use for making stock picks? Is technical analysis part of your selection process?