Why Technicals Still Matter In The Market

by: The Panoramic View

Summary

Many investors think technicals are smoke and mirrors.

Technicals can be useful as a supplement to fundamentals because they tell the investor what the market is thinking.

If the S&P 500 holds the 1900 level or the 100-day SMA, the technicals for the market are still bullish.

Many investors decry technicals. To tried and true fundamental buy-and-holders, technicals don't make any sense. How can a bunch of squiggly lines tell the future anyway?

Technicals don't tell an investor anything about the future cash flows of an equity. They don't show how sustainable the earnings are. They don't reflect a company's competitive advantages.

In the eyes of fundamental investors, trading on technicals is akin to gambling. While there is a chance that technicals may work in the short term, most technical traders will underperform in the long term from the associated transaction costs just as most gamblers are destined to lose in the long term because the odds are against them.

In some ways, the detractors are right. While some traders do succeed with technicals, most fail. Most traders simply don't have the emotional temperament for it. They become greedy during tops and fearful during bottoms. They over-trade and don't practice good risk-management.

The evidence shows how poorly most technical traders do. A Taiwanese study on day traders show that more than 8 out of 10 day traders will lose money in a typical 6-month period. The study also shows that prolific day traders do not make enough to compensate for the transaction costs.

In other ways, however, the detractors are wrong. Even though technicals may not make sense by themselves, technicals can be a useful supplement to fundamentals.

Technicals can be a supplement because technicals tell the investor what the market is thinking of a stock. If a stock makes a 52-week high or moves above a major moving average, the technicals show that the market likes the stock and believes that good things will happen to it in the future. If a stock makes a 52-week low, it shows that many market participants don't think the company is a compelling buy.

In a market that is becoming more and more efficient as information technology improves, what the market thinks matters. While the market may be wrong at times, the market is right much more often.

The market also often shows things that the current fundamentals don't reflect yet because those data points are not released. Even though market participants do not know what the earnings for a company will be, they can do research on publicly available information and indirectly determine what the earnings will be. That indirect earnings estimate is reflected in the market through prices and the associated movement, but is not reflected in the fundamentals until that earnings number is officially released.

So with that said, what do the technicals think of the S&P 500 now? Well, everyone's technical opinion is different, but my opinion is that as long as the market holds 1900 or the 100-day SMA (give or take 3 or 4%), the S&P 500 will likely continue to make new highs.

Even though many fundamental metrics such as historically high profit margins and high normalized valuations do show that the market is overvalued, the market can be irrational at times. The market traded at significantly higher valuation ratios in the 90s. It could happen again.

The current market also has significant upside momentum that will not dissipate right away - buying leads to more buying. Barring a major negative event, it will take significant time for that sentiment to change. The vast majority of Wall Street has a vested interest in keeping the bull market going so they will do their best to make sure sentiment stays positive.

With the market still holding above key technical levels even with the Federal Reserve tightening and the various geopolitical conflicts occurring around the world, the market is saying that this bull market is still alive.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.