Technical Risk and Market Culture
Technical analysts are different kinds of people than fundamental analysts. Technicians enjoy the fast-paced action of the moment and are probably more willing to take risks as traders. Fundamentalists take greater comfort in historical trends and the potential for sustained long-term growth, even to the extent of ignoring and completely discounting the chaos of short-term price movement.
Investors cannot simply become traders overnight. The risk tolerance is different and each discipline defines different kinds of people, with different philosophies about the markets and how to use them.
The topic of risk is different from a technical point of view as well. Fundamental risk is related specifically to historical financial strength and operating trends. In comparison, technical risk
is related to price volatility and trends and to related indicators (like volume, for example) that also are derived from trading action. Technical risk management requires traders to select stocks for trading that match risk tolerance, and that reflect known volatility the trader finds acceptable. This is very focused, because it involves price as a primary indicator (and for some the only indicator). Compared to fundamental risk management, this is a more concentrated form of risk management. Fundamental analysis has to test many factors including profit and loss, capital strength and working capital, dividend trends, competitive stance within a sector, and quality of management. Technicians seek indicators that anticipate changes in price movement of the stock. There is a lot involved in this process, but the focus is narrow. An observation of fundamental and technical analysis is often summarized as being the difference between hindsight and foresight, investing and trading, low risk and high risk, or conservative and speculative. These generalizations may apply, but not in every instance. An equally important difference is a reflection of market culture itself. There are significant differences in the perspectives of investors and traders that also show up as different attitudes and opinions between fundamental and technical approaches to the market. Among the many adages about the market, one applies to help make a distinction between the two groups. That is, 'The market rewards patience.' Fundamental investors tend to be very patient and methodical in their approach to the market, but technical traders need and want results immediately, perhaps within the trading day.
Key Point Technical strategists enjoy the excitement and fast action of the market. Fundamental investors are patient and willing to wait for many months, even years, to realize a profit.
Some people on the technical side find the fast entry and exit to be exciting and stimulating, and it is. Traders may be classified as occasional players in the market or as high-volume traders. For example, day trading
is an activity in which trades tend to be entered and exited within a single trading session. So by the end of the day, no open positions remain. From a regulatory point of view, day trading presents a problem of a different kind of risk. All margin requirements are based on positions at the end of each trading day, so day traders can execute a high level of trades and use leverage to expose themselves and their brokerage firm to risk, but without incurring any margin requirements. For this reason, a requirement was put in place to identify pattern day traders
and require them to maintain a minimum cash and securities value of $25,000 in their accounts. This individual is defined as anyone who executes trades in the same stock four times or more within five consecutive trading sessions. If orders reach this level, they will be banned if the trader does not have an account with the broker with at least $25,000 in cash or securities.
To learn more about the rules governing pattern day traders and margin requirements that apply, go to www.finra.org/Investors/SmartInvesting/AdvancedInvesting/DayTrading/P005906
Day traders do not close positions the same day they are opened specifically to get around margin requirements. Many traders believe that trading trends can be identified and acted upon within very short time periods. In fact, one of the amazing facts observed by traders is that chart and price patterns occur regardless of the time duration being studied. Most people who are not day traders use daily charts as the default time duration, and technical patterns are observed on a day-to-day basis. This works for nonâ "day traders willing to hold positions open for more than a single trading session. The day trader, however, uses charts based on more frequent changes. With the Internet, it is easy to create instant charts and track live feeds for any listed stock, with increments that track on any time period desired. For day traders, five-minute charts provide valuable information about developments in price trends as they evolve.
Key Point The observed price patterns that are used to signal entry or exit work in all time durations. So whether you use a daily chart or a five-minute chart, you will find the same technical signals.
The five-minute chart patterns that develop are going to exhibit the same price and chart trends as the daily charts do. However, in a daily chart, the trend encompasses an entire day and many interim price patterns do not show up. So the day trader's argument for more frequent increments in charts is that many entry and exit opportunities are lost in the longer-term chart. Of course, this rapid-action charting system is not for everyone. The dedicated day trader is likely to observe hour-by-hour tendencies in price patterns. A lot of study has gone into analyzing how price trends develop throughout the typical trading day. For example, some traders will tell you not to make trading decisions in the day's first hour. Others believe it is a mistake to put in an order during the Wall Street lunch hour. And many believe that the last hour of the day is when most trends make their move.
Key Point Isolating trading activity to specific times of day adds yet another element of timing to the technical decision. Traders find methods that work for them and provide discipline to make their strategies work.
For anyone inexperienced in trading, the world of day trading is probably too risky. However, the excitement of making decisions by the hour or even by the minute is difficult to match. The more analytical, long-term fundamental approach is comparatively dry and unexciting, even if it may ultimately be more profitable. The truth is that picking high-value stocks and holding them for many months or years is usually profitable, but traders need and want that daily action to make the experience satisfying. This is the big difference in market culture. The fundamental analyst is likely to be a value investor using a buy-and-hold strategy. The trader, especially the day trader, does not want to own stock for more than the minimum time needed to generate a profit. There are merits and flaws in both systems, without any doubt. It makes the most sense to remain open-minded to both strategies, and even to combine investing and trading in your portfolio. Day and Swing Trading
expands on the discussion of trading to examine day trading in more detail, and to compare various trading systems.
By Michael C. Thomsett