Saturday, April 20, 2024

What You Should Know About Technical Analysis and Compound Interest

Anyone who follows the financial markets is bound to hear discussions about the merits of technical analysis versus its fundamental counterpart. On the surface, technical analysis should not be related to compound interest investors because consideration of underlying values just goes out the window; however, there are some interesting aspects thereof that all investors should be familiar with.

The History of Technical Analysis in Trading

Even though compound interest is an ancient financial concept dating back to Babylonian times, its first practical application opposing simple interest did not emerge until merchants in the Republic of Florence formally adopted it in the 17th century. Around the same time, traders in the Amsterdam stock exchange, which was founded by the Dutch East India Company, were already applying technical-analysis principles to guide the positions they took on the market. A century later, Japanese commodities traders introduced the use of candlestick charts in order to profit from the rice market.

move in accordance with previous trends

The bottom line of technical analysis is that markets will often, but not always, move in accordance with previous trends. In turn, trends are established by the whims of investors, which is why technical analysis is largely behavioral and psychological. When you see the complex charting instruments used by technical traders, what you are looking at is the historical reaction of traders to certain market factors.

Technical Analysis vs. Fundamental Analysis

Many high-profile investors such as Warren Buffett, who happens to be a major supporter of compound interest investing, count themselves as detractors of technical analysis. Buffett is the ultimate advocate of fundamental analysis, so it should not be surprising to learn that he does not think much about investors who thrive on technical analysis; nonetheless, quite a few Wall Street investment banking firms actively trade on volume, momentum, and data patterns. In the 21st century, high frequency and algorithmic trading are doing away with technical analysis as an investment strategy.

learn from past mistakes

What compound interest investors can take away from the technical analysis is the following: Hindsight is always 20/20, but it is useful only if you are willing to truly learn from past mistakes. If you pack your investment portfolio with corporate bonds that ended up going bust ahead of time, it would be a good idea to take a look at a price movement chart just before the bond crashed; you will likely have noticed a price uptick during a high volume period before the unfortunate end, and this represents technical traders swooping in to make quick profits prior to the crash. If anything, technical analysis teaches you to be on top of your portfolio.

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