If there is one thing that bugs a lot of market participants is the credibility of the Technical Analysis and understanding whether is it useful or not in actual application. Here I am trying to map out the exact myths and facts of Technical analysis in simple terms which might help us to grasp the key points.It is not the first time such a debate is proposed under the table. This is going since last 3 decades with some participants advocating technical analysis while some strongly rejecting it, citing as useless.
One of the greatest enemies of technical analyst is none other than the economist Eugene fama who proposed Efficient market Hypothesis,the theory which hammered the Wall street market players, especially technical analysts who were employed in respective research companies such as Ned-Davis etc
But again as the professions with sociological background such as Economics, Finance, Psychology where reality beats all the axioms to death EMH is not an exception.The emergence of 1982 stock market crash, soon everything was put to debate again.
While keeping all these controversies aside, Let us look at the benefits by harnessing the technical analysis and also the Myths which comes along with it.
First Let us debunk the Myths:
1.Technical analysis is a science of Predicting Market Movements
Really? No, It’s not a science, Technical analysis is more of an art than science and all it does is study the past price movements,Environments and try to guess the future price movement with some probability
2. A Technical Trading system which gives automatic buy sell signals can replace a good trader.
If You ever managed to speak with a successful trader in Wall street,try asking him this question and most likely the answer will be “No”. Whatever Trading system you might use, Without a good Trader it would not be profitable in the first place
3.Technical Analysis is all about charts and nothing else
This is a idiotic conventional wisdom that is preached since the writings of John Edwards and Robert Magee in their beloved book-“Technical analysis of stock trends”.It is considered as the bible of technical analysis! Nothing can get more worse than this, Technical analysis is used before Dow theory by pit traders with simple understanding of key levels.Even Charles Dow, the creator of Dow theory never said such a nonsense! In other words his acronym “Market discounts everything” is totally misunderstood.With simple or useful definition Technical analysis is all about understanding the Market’s behavior in simple and efficient manner or A key for reading Market psychology and making educated guesses about future Price movements.Chart is an efficient tool but not everything is in it
4.More Deeper Analysis using technical charts can lead to profitable results.
This myth haunts everyone especially if you’re a beginner, As acronym states Keep it simple stupid which applies profoundly to technical analysis Vigorously seeing the charts top to bottom doesn’t leads you to be profitable neither gives an uncanny ability to predict the market Technical analysis can only show you what has happened and what is happening, but it doesn’t say anything about what will happen in the future.
5.Technical Analysis can Make you rich within short time period
This is a basic thesis used by Jackpot tips providers and unfortunately investors fall in that vicious prey again and again, Whether you’re a technician, a Fundamental Investor or A Quant everything is boiled to one concept that is Probability.We are living in a world of probabilities there are no guarantees After all we are faced with an option of anything can happen and markets are a great example for that.
So these are the common myths associated with Technical analysis Now let’s take a look at the advantages of Technical analysis
1. Entry point and exit point
Technical analysis actually shows a more specific way of when we can go into the game, and purhcase some stock. If we are educated enough, we will have the ability to interpret the entry and exit point of the stock. It will allow us to maxmize our gain on the stock.
2. Volume trend
It tell us about the traders sentimental, and what is going through the mind of most of the traders, because the market is govern by supply and demand, we will be able to know roughly what other investors are thinking. High demand will push up the prices, and high supply will inverse push down the prices, therefore from there, we can judge how the overall market is working.Together with price, we will be able to identify correction, in which its a more advance way of looking at the prices and volume. It can also help us see a sudden increase of volume, in the intraday chart, to enable us to know if there is a community of buyers having the same sentimental, or institutional ownership, or just simply a damn rich guy.
3. Short term market indication
It provide a short term market indication, for example we want to earn a 10% profit of the stock, we can time our entry, and minimize the time usage, (because by buying one security, we are locking in our asset, and not being able to buy others) and getting the goal we want. its more specific.
4. Visual indication and Pattern Analysis
There are some chart patterns which are proven that if it happen, a very high chance of a certain pattern will follow after that. As human, we are more visual centered, we like to see more than hear, therefore by looking at diagram, we can actually track down pattern, and aid in our decision making faster. Price pattern also repeat overtime, so if we are going by technical analysis, most likely, we will not be lured to make other decision by the noise made by other investors and expert (noise refer to the senseless and meaningless talk about stocks.)
Alright in conclusion, its a powerful and valuable tools, it will be good if its use together with fundamental analysis, just like what William o Neil does, we must be open to more methods for our own financial good and in order to become Profitable.
11 Replies to “Benefits and Myths of Technical Analysis”
i got more confused by Balaji. without a set of indicators a trader is lost. what set he chooses is his decision, however..
no indicator or trading skill can predict a reversal with about 90% certainty, can it? this is one area i feel indicators fail in. if balaji can recommend how to spot a reversal in advance, i would be grateful.
Could you Elaborate where I have mentioned about indicators?However in point 2, I referred the Trading system will only be profitable when the trader who uses it should be good enough to cut the losses and manage money efficiently.That might have confused you because I didn’t put up everything in the para
In case of reversals there are 3 types:
1.Trend reverses to Rangebound Market
2.Rangebound Market reverses to Trend
3.Trend reverses to Opposite Trend
May I know which reversal you are mentioning to-out of these three?
Thanks for the prompt answer Balaji!
No, I find that you didn’t use the word “indicator” at all, But since indicators are a big subset of TA, indicators and TA have become synonymous to me. I really meant “TA using indicators”, and volume, support resistance can also be broadly taken as indicators I suppose.
I am more interested to predict trend reversals trend to trend, not really range to trend or vice versa. Any tips?
I am trying to set up an auto system seriously. The afl is good but Amibroker is a game spoiler in the auto scene. My broker has given me a plug in which transports signals to the platform. The test is on for the last couple of days. I hope to make some profits despite AMI, but keeping my fingers crossed.
But don’t you think an ATS would beat a human hands down because it is on job all the time, is blazing fast and bereft of emotions?
It looks like benefits of a trading strategy and trading system has to sink in to the individual trader and unless he believes both the benefit and market filter he does not violate the system he follows.
I have been thinking that every market event has to be analysed to certain depth on how it the affect the market consensus ratio(BULL versus bears) on market direction. (This is thinking about how others will think). But it is very risky by doing such analysis if it is correct great. But one tend to have strong self buy-in that results in anchoring so it becomes a me versus market (it gets emotional). It become difficult to change stand. However in corporate setup the market stand is well debated and is ensured that it sinks in to one self. However for a individual retail trader cross verification is not possible as he has to believe in himself.
For example in march 2014 I remember February 2014 bank nfity closed at around 10300. It was kind of range bound till then. Then came CAD number it was low then came the market hypothesis about economy turning around and election game. This kind of hypothesis driven market decision may be right but sticking to market reality sometime get difficult. But whether market will become a range bound market after hitting a high is difficult to say. FII seems to have extraordinary patience this time.
However technical indicator brings one to reality quickly with less loss. I thinking that is very good thing about quantitative trading systems. I think one used to Technical indicator does find it difficult to take buy call of bank nifty even at 18450
I think one used to Technical indicator does not find it difficult to take buy call of bank nifty even at 18450
I just read the link from Balaji on what to do and not to do in trading. I am trying to form my own trading personality by trying to understand what others are saying. Good advice, Balaji!
After reading that I got a little anxious that I trade intraday on indicators like MA, MACD,TSF, etc.. I am a consistent loser at manual trades so I have gone for auto but I use the same indicators.
My question to Balaji is:
My afl shows profitable signals. If the plug in transports the signals to the terminal faithfully am I not going to profit? Balaji seems not in favour of indicator based Intra Day trading.
Well to be honest with you, I don’t believe in conventional Indicators at all ! But there is a simple ideology in your trading style as you have mentioned shifting from Manual to semi-automatic system.There is much advantage of eliminating the emotions which might give you an edge in the market an emotional edge.But on the other hand your trading system has to be consistently back tested and need to be understood on the basis of weakness and strength,so from that point of view you need to have a systematic edge,which means winning ratio has to be greater than 40-50% only that can guarantee a sustainable profit in the long term.For me it’s all about trading pure price action.Every indicator is a derivative of price and thus price itself is a final product of market psychology,I use some indicators just for confirmation and nothing else. I have my own trading philosophy which helps me to make a living by the market-but as everything said YOU SHOULD STICK WITH WHAT WORKS BEST FOR YOU
Thanks again, Balaji!
I have my back to the wall as I have lost all my savings in manual trading. As my afl is producing more than 50% trades on the right side, while the stop losses are small, I think I should go by it. Let me see how it turns out 🙂
You are right about the corporate setups as they have access to special materials and tools which makes a significant advantage over retail traders especially in reading the entire market situation but that doesn’t stops an average guy from successfully beating the game.I left the corporate circle a couple of years back but that didn’t stopped me from the game.I found successful substitutes to aid me in my trading decision.Regarding technical indicators there is one simple fact-they all work during best market situation but fails during worst times especially around crashes and panics where most profits can be made that doesn’t mean technical indicators are useless,I meant to say we cannot totally rely on technical indicators for everything they are a mere market timing tools.Even Quants or automated traders rely on statistical evidences and anomalies captured by system not merely on the system itself
As far as I understand Markets are of only one type they are only trending. They are either trending on 1 minute, 5 minute , or 10 or 15 minute or 30 minute or 1 hr or 1 day or 1 week or 1 month an so one. The use of word range is very ambiguous either from time perspective or from price perspective. If we find a need to trade on 1minute chart we should not trade I think so. But it is difficult to follow.
Deciding on which5. chart to follow at what times is a difficult decision only experience will tell.
Further I find following trade method,
1.. Trend following
2. .Statistical arbitrage
3. Deterministic arbitrage
4. News Following
One Individual trader needs to do a lot for trading single handed,
1. Understand market setup and market pulse
2. Define trading rules
3. Apply trading rules for each trade both on buy and sell side
4. Make multiple decision while he trades(This is really taxing if a person doe snot have means)
5. Keep changing rule based on different market conditions
6. Be aware of Market infliction points like a fed event or major event
7. Be disciplined(This actually mean doing not what you minds says but doing what you have previously decided in calm and composed manner a set of do’s and don’t)
8. Most important all the rules to be recording in the trade system and not in the mind or analysis system.
9. I feel by enabling automated system for large traders and not enabling automated trader for retail traders SEBI is running a unfair markets.
So it very taxing mentally to do so many thing by one person, hence more of the activity automated out of the human mind and more of monitoring will help a trader be efficient and make him capable of creating incremental wealth.
Would like to invite input on what charts to select on what kind of markets. What are things which are essentials for relaxed trading