The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 23

Moving with the Moving Average

An amazing contradiction lies in the battle between two major schools of investment analysis—technical versus fundamental. Technical analysis looks at the past action of a stock, the market, interest rates, or some related event and bases forecasts on that information. Fundamentalists base forecasts on valuations like P/Es or book value, coupled with analyzing future trends for the economy, industries, or single businesses.

There are plenty of adherents to each style, but the fundamental folks dominate for two main reasons. First, all the legendary players who've repeatedly made big bundles decade after decade came from the fundamental side—not a technician in the bunch. Second, there has never been a serious academic study demonstrating that a security's prior price action has anything to do with its future price action. So, most pros consider themselves fundamental analysts—your author included.

Ironically, all the great fundamentalists I've known or read about used a few disguised technical tools with their overriding fundamentals. Why? Some things seem to work—at least a bit. Consider the amazing success of the simple 40-week moving average, which starts with the sum of the closing price for the last 40 weeks divided by 40. Then, each week you do the same thing, adding the new week's price and dropping off the first week's. When the market is above its moving average, it's thought to be bullish. When it's below its average, it's bearish. ...