Why does technical analysis work on indices?

dbphoenix

Legendary member
6,953 1,260
Oh and also - I'm not at all certain what is the difference between the 'swing points' you mention and the resulting trend line plotted from them (maybe when I read the above link you mentioned it will clarify this).......

But I have proved to myself over and over again I can draw a line on a chart that the market price will have a decisive reaction to hours or days later. I can't necessarily predict what the actual reaction will be (yet?) though i do try to look for entry points, but price does almost always react noticeably at that pre-drawn trend line

So from this observation is it reasonable to take some satisfaction from the fact I am learning to draw them correctly?

And from what you say... that would be a very good ability to aquire?

Rich

Price movement is in the market. Whatever lines or patterns you may draw or indicators you may apply are in your head. It is illogical to believe that millions of traders all over the world are going to reverse price at something you've drawn and which they know nothing about. Any movement at your line will be purely coincidental. This is not to say that your lines can't be useful, but you are making illogical and incorrect assumptions about the information they provide.

There are several cognitive biases going on here, chief among them Confirmation Bias. Guard against them.
 

timsk

Legendary member
7,601 2,376
. . .This is not to say that your lines can't be useful, but you are making illogical and incorrect assumptions about the information they provide.
Hi Rich,
It's worth pointing out, I think, that believing there's something 'meaningful' about price appearing to react to a line you've drawn or an indicator etc. is a very common reaction and one that many traders cling to throughout their trading lives. So, you're far from alone in this: it's not a newbie error. Indeed, I can think of more than one esteemed member (and experienced trader) of this forum who will argue till they're blue in the face that price 'bounced off his MA' and that his 'trendline provided resistance/support' etc.

I hope dbp will agree with me when I say it doesn't much matter what you believe about the markets and how they function and whether or not you make illogical and incorrect assumptions if (big if) your PnL is in the black and growing. If it's not, then questioning your thoughts on this issue could be well worth exploring.
Tim.
 
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richy96

Member
54 2
@tim, dbphoenix

No worries, I'm not thinking you guys are 'having a go at me' if that is what was in your thoughts.

OK, I did think after posting that 'the price bounced of a line that I drew' is the wrong way of putting it.

Of course I can understand the fact that price reversals would occur whether I drew that line or not. Like you say the market has no idea that I drew that line, and even if it did, why would it care?

This is a bit like arguing whether a falling tree would make a noise if no one was there to hear it, isn't it?

Maybe what I should have said is I do seem to have developed a knack of drawing lines, that regularly predict future points at which price is going to change it's direction or momentum. Not always of course... but often enough to be significant.

Whether the price 'bounced of a line I drew' or the line 'helped me predict future price movements', doesn't it just amount to the same effect?

So whichever you want to call it (are we just being pedantic? does it matter?) I think that must be a worthwhile skill to have learned. To me anyway.

Rich
 

dbphoenix

Legendary member
6,953 1,260
Whether the price 'bounced of a line I drew' or the line 'helped me predict future price movements', doesn't it just amount to the same effect?

Perhaps, but it is nonetheless irrelevant. Every trader in the world knows what yesterday's high and low were in the Dow, the S&P, the Dax, and so on. Nobody can see your line. Therefore what everyone knows and can see is more likely to be a catalyst for price movement than something that they can't see and know nothing about.

The markets may not always be rational, but they are always logical, at least to those who trade to make money.
 

Fugazsy

Veteren member
3,661 677
No. You're equating "technical analysis" with indicators and patterns. Technical analysis is the analysis of price movement. Indicators and patterns are allegedly tools to aid in that analysis. But without a thorough understanding of price movement the tools are useless. If it were otherwise, the success rate would be far greater than it is.



The MACD has nothing to do with volume.



S&R levels may or may not be useful depending on whether or not the trader is drawing them correctly. Nearly all struggling traders draw them incorrectly. Therefore their levels are useless. Yes, Fib levels are useless. Trendlines may or may not be useless depending on how and where they are drawn. If drawn correctly, they can be useful. If not, they are of no more use than any other line.



The trendline is in your head, not in the market. As the market can't know what's in your head, it couldn't care less about your trendline. What is in the market and therefore a catalyst for reaction are the swing points that are used to draw the trendline, not the trendline itself.



An illusion.



See above.



There are other choices, the chief among them is understanding price movement. This need not involve drawing lines of any sort. Or "patterns". Or plotting indicators. One needs primarily to understand the difference between up and down and those transition points and levels where one becomes the other.

If you want to pursue this, I suggest you read my Trading Price thread (link provided in my signature.

Good read, post 7 in particular.
 

techst

Active member
243 3
I know that sounds like an odd question but let me explain.

As I understand it, technical analysis is basically a self fulfilling prophesy.

Forgive me if I am wrong, but many many traders look at the same charts and see Support and Resistance levels, trend lines waiting to be broken, double tops, double bottoms, fibonacci levels, special cycles, patterns, moving averages, divergences etc and they all use those same levels (Admitedly in many different ways) to decide their entry and exit points.

So therefore price will bounce off a trend line or fibo level, broken support will become resistance etc simply because there are so many traders looking for those levels, they make it happen. I can't think of a better explanation for why Technical analysis works on Forex, shares etc.

If the above is a true explanatoin for why TA works then what has me puzzled is why it works on indices. :confused:

For example the value of the FTSE 100 is simply a sum or some such calculation of the value of the top 100 shares at any given moment. Now I can understand why technical analysis. would work for each of those shares individually for the reasons above, but in that case wouldn't the value of the index itself be chaotic - as it is made up of the TA applied to so many different shares, all of which behave in different ways at any given moment?

I hope I explained the question well enough to make sense.

Any thoughts anyone?

Rich

For what its worth Richy, I think this is a really interesting question. How can the FTSE have support a level X if level X made up of 100 different stocks? Are we giving to much respect to technical analysis with regards to indices?

I really do not pay to much attention to exact levels on indices, I like to know if its going up or down or sideways I then trade individual stocks in that direction.

good on yah for posing this question :clap:
 
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russell444

Newbie
6 0
technical analysis does not work for index trading

You say: FTSE reflects what is happening to the FTSE futures which are directly tradeable and therefore subject to the trader activity that causes TA to "work.
This is not correct. the FTSE does not reflect FTSE futures at all. The FTSE reflects the average of all the share price shanges of all the companies in the index. Thus, any kind of technical analysis for index trading is worse than useless.
 

FXX

Experienced member
1,267 259
It's actually a little more complicated than an average. It's comprised of prices, shares, free float, a divisor, etc... The selection process is weighted by market cap

Its actually one of the simpler index formulas out there



Sent from my SM-G950F using Tapatalk
 

mpups

Experienced member
1,024 143
You say: FTSE reflects what is happening to the FTSE futures which are directly tradeable and therefore subject to the trader activity that causes TA to "work.
This is not correct. the FTSE does not reflect FTSE futures at all. The FTSE reflects the average of all the share price shanges of all the companies in the index. Thus, any kind of technical analysis for index trading is worse than useless.

Wow.. talk about blind leading the blind

but to be fair, barjon was wrong in what he said:

FTSE reflects what is happening to the FTSE futures which are directly tradeable and therefore subject to the trader activity that causes TA to "work" if it ever does..
 

barjon

Legendary member
10,705 1,809
Wow.. talk about blind leading the blind

but to be fair, barjon was wrong in what he said:

In what bit? That FTSE reflects what is happening to the FTSE futures? The vexed question of whether TA “works”. Or the way I happen to use it?
 

mpups

Experienced member
1,024 143
In what bit? That FTSE reflects what is happening to the FTSE futures? The vexed question of whether TA “works”. Or the way I happen to use it?

hello

Just the bit about the calculation. Its based on a formula, as fxx mentioned, not the futures contract. Unless you were referring to an OTC price after hrs.
 
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barjon

Legendary member
10,705 1,809
hello

Just the bit about the calculation. Its based on a formula, as fxx mentioned, not the futures contract. Unless you were referring to an OTC price after hrs.

Yes, absolutely. That’s why I said that ftse REFLECTS what is happening on the futures, not that it is calculated from the futures. If you prefer, what happens with the futures influences the price of a basket of shares to the degree that the onward calculation of ftse moves it by a similar degree to the futures. The futures and the index keep pretty much in step. Similarly, the other way round, what happening with shares (and hence ftse) can influence what happens with the futures.
 

mpups

Experienced member
1,024 143
Yes, absolutely. That’s why I said that ftse REFLECTS what is happening on the futures, not that it is calculated from the futures. If you prefer, what happens with the futures influences the price of a basket of shares to the degree that the onward calculation of ftse moves it by a similar degree to the futures. The futures and the index keep pretty much in step. Similarly, the other way round, what happening with shares (and hence ftse) can influence what happens with the futures.

I did notice that you said reflects. In the context of the thread question though any reverse influence from the futures contract would be mostly irrelevant. The index is calculated from the underlying stocks.
 

FXX

Experienced member
1,267 259
Yes, absolutely. That’s why I said that ftse REFLECTS what is happening on the futures, not that it is calculated from the futures. If you prefer, what happens with the futures influences the price of a basket of shares to the degree that the onward calculation of ftse moves it by a similar degree to the futures. The futures and the index keep pretty much in step. Similarly, the other way round, what happening with shares (and hence ftse) can influence what happens with the futures.
It doesn't reflect what's happening on the futures. Its calculated off a formula and that formula has zero parameters that's derived from the futures market (i work at an an index provider and very familiar with the process). The futures market reflects the a market of hedging risk on the underlying. There is zero influence the futures market has on the underlying index because the formula is based on the composition data and not a future value component.

Go look at ftse calculation pdf if you don't believe me.

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mike.

Senior member
2,101 709
Good post fxx, Ive often wondered why the indexes have such a positive correlation, Could you explain the above in a little more detail or by means of an example ?
 
 
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