Technical Analysis

Debunking Eight Myths About Technical Analysis

Some traders and investors denounce technical analysis (TA) as a superficial study of charts and patterns without any concrete, conclusive or profitable results. Others believe it is a sort of “Holy Grail” that once mastered will unleash sizable profits. These opposing viewpoints have led to misconceptions about technical analysis and how it is used.

Some misconceptions about technical analysis are based on education and training. For example, a trader trained in using only fundamentals may not trust technical analysis at all. But that doesn’t mean someone who is trained in technical analysis can’t use it profitably. Other myths are based on experience. For example, the incorrect use of technical indicators often leads to losses. That doesn’t mean the method is necessarily bad – possibly the person just needs more practice and training. Other myths are perpetrated by marketing, promising overnight riches if a simple indicator is bought and used. Rarely is it that easy.

Technical Analysis Myths Debunked
Here are eight common technical analysis myths with opposing viewpoints as to why these myths simply aren’t true.

1) Technical analysis is only for short-term trading or day trading.
It is a common myth that technical analysis is only appropriate for short-term and computer-driven trading like day trading and high-frequency trades. Technical analysis existed and was practiced before computers were common, and some of the pioneers in technical analysis were long-term investors and traders, not day traders. Technical analysis is used by traders on all time frames, from 1-minute charts to weekly and monthly charts.

2) Only individual traders use technical analysis.
While individuals do use technical analysis, hedge funds and investment banks make ample use of technical analysis as well. Investment banks have dedicated trading teams that use technical analysis. High-frequency trading, which encompasses a significant amount of the trading volume on the stock exchanges, is heavily dependent on technical concepts.

3) Technical analysis has a low success rate.
A look at the list of successful market traders, who have decades of trading experience, debunks this myth. Successful trader interviews have cited significant numbers of traders who owe their success to technical analysis and patterns. For example, “Market Wizards: Interviews With Top Traders” by Jack D. Schwager cites many traders profiting solely from technical analysis.

4) Technical analysis is quick and easy.
The internet is full of technical analysis courses that promise trading success. Though many individuals enter the trading world by placing their first trade based on simple technical indicators, continued success in trading requires in-depth learning, practice, good money management and discipline. It requires dedicated time, knowledge and attention. Technical analysis is only a tool, only one piece of the puzzle.

5) Ready-made technical analysis software can help traders make easy money.
Unfortunately, this is not true. There are many online ads for cheap and costly software that claims to do all your analysis for you. In addition, less-experienced traders sometimes confuse technical analysis tools in broker-provided trading software for trading models that will guarantee profit. Though technical analysis software provides insights about trends and patterns, it doesn’t necessarily guarantee profits. It’s up to the trader to correctly interpret trends and data.

6) Technical indicators can be applied across all markets.
While this may be true in many cases, it is not true in all cases. Specific asset classes have specific requirements. Equities, futures, options, commodities and bonds all have differences. There may be time-dependent patterns like high volatility in futures and options nearing expiry, or seasonal patterns in commodities. Don’t make the mistake of applying technical indicators intended for one asset class to another.

7) Technical analysis can provide very accurate price predictions.
Many novices expect recommendations from technical analysts or software patterns to be 100 percent accurate. For example, inexperienced traders may expect a prediction as specific as, “stock ABC will reach $62 in two months.” However, experienced technical analysts usually avoid quoting prices so specifically. Rather they tend to quote a range such as, “stock A could move in the range of $59 to $64 in the next two to three months.” Traders betting their money on technical recommendations should be aware that technical analysis provides a predictive range, not an exact number. Technical analysis is also about probability and likelihoods, not guarantees. If something works more often than not, even though it doesn’t work all the time, it can still be very effective at generating profits.

8) The winning rate in technical analysis should be higher.
It’s a common myth that a high percentage of winning trades is needed for profitability. However, that is not always the case. Assume Peter makes four winning trades out of five, while Molly makes one winning trade out of five. Who is more successful? Most people would say Peter, but we don’t actually know until we get more information. Proper trade structuring allows for profitability even with few winners. Profitability is a combination of win-rate and risk/reward. If Peter makes $20 on his winners but loses $80 on this loss, he ends up with $0. If molly makes $50 on her win and losses $10 on her losses, she walks away with $10. She is better off, even with fewer wins.

In Summary
Technical analysis provides a large basket of tools and concepts for trading. There are successful traders that don’t use it, and there are successful traders that do. Ultimately, it is up to each trader to explore technical analysis and determine if it is right for them. It doesn’t guarantee instant profits or 100% accuracy, but for those who diligently practice the concepts, it does provide a realistic possibility of trading success.

Shobhit Seth can be contacted at: FuturesOptionsEtc

Shobhit has a Master’s degree in Financial Management (Specialization in Derivatives & Quantitative Research), The Netherlands and a Bachelor of Technology degree (Electronics & Communications Engineering), India.

He is a freelance financial writer, derivatives trader and consultant specializing in derivatives pricing and quantitative research. His career spans over 14 years with a position of Product Manager (Derivatives, Financial Data & Risk Management) at leading financial services companies across UK, Europe, US and India. He has written extensively on topics pertaining to Derivatives Pricing, Derivatives Combinations & Structures, and Derivatives Trading Strategies. A lot of his work is available at www.FuturesOptionsETC.com, a site on Derivatives Trading which Shobhit owns and maintains. Shobhit also has expertise in index based products and ETFs and he conducts training sessions on derivatives and related financial topics.

Shobhit has a Master’s degree in Financial Management (Specialization in Derivatives & Quantitative Research), The Netherlands and a Bachelo...

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having worked at investment banks I can assure you they are more focused on risk models and fundamentals than technicals. It is such a small part of their trading its almost not worth discussing. Where has the author has sourced the info regarding investment banks and their use of technicals, is it just an assumption! they do put out technical analysis for clients but I have been very close to those teams across several investment banks and it was more of a public display than anything else. They tend to use junior analysts for this as well, people that don't trade for a living.