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Technical Analysis: True or Farce Fans of technical analysis can be quite passionate in their support of their tools. So apologies in advance if my comments ruin anyone’s weekend. In my view, some of the tools so treasured by technical analysts, or chartists, fail to work as billed. They do not consistently deliver profits to practitioners. A brief history of technical analysis illuminates the problem. This field was once the domain of a small group of nerdy investors. They spent their days making lengthy calculations and posting results to graphs, all by hand. The procedures followed in the 1980s were little changed from those in place 100 years earlier. The computer revolution changed everything. The first wave of change enabled investors to quickly produce data that once took hours to prepare. Graphs could be drawn with a few keyboard clicks. It became easier for innovative statisticians to devise fresh tools to help predict the future. There now are hundreds of indicators. We are currently in a second wave of the revolution. In today’s online world, many investment websites offer sophisticated charting services for free. Information providers compete to offer an ever-increasing numbers of analytic options to budding analysts. I get the feeling that almost every investor is now a charting fan. There are now two separate segments in the field of technical analysis. The basic level relies upon time-honoured concepts such as moving averages and support or resistance lines. Investors use them to spot underlying trends and pinpoint areas where earlier waves of buying or selling ran out of steam. These basic technical analysis tools to spot entry and exit points for short-term trades work well to an extent. There is nothing like watching a share price approach a long-term support line, coupled with a surprise good news announcement, to get your juices going. But I have less confidence in the newer and more complex aspect of technical analysis. This is the segment that relies upon mathematical relationships with exotic names such as oscillators, Fibonacci retracements and Elliott waves to predict the future. Supporters believe these indicators give accurate insight into the future. But the truth is that there is little objective evidence to support this view. Some traders who I respect tell me that day-to-day currency and commodity trading is largely technically-driven. Profitable trading in these arenas demands careful attention to technical analysis. Fair enough. But when it comes to the stock market, I have never met anyone, aside from newsletter publishers and authors, who consistently profited from trades based upon exotic technical analysis tools. Every tool may have its moment in the sun, but a sudden reversal always seems to catch practitioners by surprise. Remember the old children’s fable, The Emperor’s New Clothes? It was about a naked emperor who believed his new suit could only be seen by worthy individuals. An unpretentious child eventually blurted out the truth. I fear this tale applies to some exotic technical analysis tools as well. I welcome data from any reader with objective evidence that proves otherwise. Exotic techniques are probably doomed to failure because of the “Success Breeds Failure” syndrome. In a nutshell, the more accurate an indicator, the more likely that traders will trust it. Eventually, some will act before the indicator signal actually flashes to beat the competition. As more and more traders jump the gun, prices start to shift significantly before the signal flashes and the indicator stops working. Don’t take my word that technical analysis is unreliable. Ask yourself a simple question. If an exotic technical analysis tool really worked as billed, why would its developer tell the rest of the world about it and risk killing the goose that lays the golden egg? |
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