How valid is technical analysis?

[Lopen 10]

Im still new to technical analysis but would like to know if this really works? This whole concept seems to work just because traders believe in it.

[Soultrader 12]

  Lopen said:

Im still new to technical analysis but would like to know if this really works? This whole concept seems to work just because traders believe in it.

 

TA is folllowed religiously by many traders. From my experience TA works better on longer time frame charts such as the daily chart. Alot of price patterns on 1 minute and 3 minute timeframes are not as valid.

 

TA is the study of price patterns based on human behavior. It uses crowd behavior to its advantage. Remember, TA is not 100% exact science. Trading is a game of probability. As long as you have discipline to honor your stops and ride your winners you will come out ahead.

 

I don't rely heavily on TA for my trading. But some of the most powerful trading signals come when price patterns line up with pivot points. These setups I will take 100% of the time.

[Peter 10]

Technical analysis is widely known to the public now. This causes alot of pattern failures. When technical analysis was known to a few traders back in the days, it was highly profitable. Now alot of patterns simply do not work because everyone is seeing the same thing. Try learning classic price patterns then devise pattern failure strategies. If you know what everyone else is looking at then you can use that information to your advantage.

[jperl 11]

  Lopen said:

Im still new to technical analysis but would like to know if this really works? This whole concept seems to work just because traders believe in it.

 

I hate to be cynical about this, but there is no evidence to support the use of technical analysis as a way to be profitable. In fact the vast majority of traders who use TA lose money.

We can have a long discussion here as to why TA does not "work", but the bottom line is, TA is based on a linear representation of market data when in fact market data is very much non-linear in behavior.

You need only to draw a linear regression line through as many data points as you like and then note that as you add more data, the linear regression line changes. Another way to understand this is to look at the price or volume histogram of a series of price points and note that it is very much non gaussian (that is to say it doesn't have a NORMAL DISTRIBUTION). In addition whatever distribution it has today, will be different tomorrow. Since most TA is based on the distribution being NORMAL, any TA analysis will be a poor representation of the data.

What does that leave you with? Not much. What you can be sure of is what the distribution looks like right now (you can plot a histogram of it) and hope it will stay that way long enough for you to pull some money out of the market.

JERRY

[Soultrader 12]

Excellent point Jerry. I have to agree with you completely on this. I was in a pretty intense debate a few weeks back on how I thought technical analysis was useless in trading. Didnt quite want to start it here but oh well.... might as well.

 

My honest opinion: technical analysis is useless. There, I said it.

 

I dont think I have ever used TA to day trade the markets. By this I am reffering to price patterns and not TA tools such as pivots and S&R. I am reffering to common patterns that everyone knows such as triangles, flags, pennants, etc...

 

Im sure there are traders who trade these patterns successfully. However, I find it pretty useless in intraday trading the index futures.

 

Jerry, I want to ask you a question. Can you elaborate on your point of normal distribution? I would like to understand this concept a little better. Thank you

[Kiwi 16]

1. This argument seems to be off the rails because:

 

You guys are incorrectly defining technical analysis. The simplest definition of TA in trading is to trade based on what happens Price and Volume alone.

 

That is you exclude fundamentals, the stars, what your dog did yesterday and tips. It doesn't have to mean patterns, it doesn't have to be linear, it basically differentiates price/volume based decisions from fundamental analysis.

 

So, buying support and resistance, using market profile, using volume at bid vs ask analysis and using indicators or patterns are all examples of technical analysis. Choosing targets, analysing MFEs and MAEs to determine stops and targets, points for tightening stops and determining RR of potential trades are all Technical Analysis.

 

2. Jerry is right that most traders are losers at any one time (some climb out of it) but its not because of TA. Most traders are losers because their brains are wired wrong. A trader may know what to do (semantic memory) but do the wrong thing repeatedly (procedural memory). It doesn't require FA, TA or any analysis at all ---- most traders will be losers just because

 

3. It is true that market price doesn't have a normal distribution but that doesn't prevent approximations to nds from being effective (otherwise why bother with market profile?) But other than market profile and statistical work most of technical analysis doesn't care what the distribution is - it doesn't give a flying xxxk!

 

Most TA that works with trends benefits from the fat tail distribution - we get an unreasonable number of long moves! Most TA that works with edges also doesn't care. TA is based on crude robust statistical assumptions and doesn't assume a distribution. And one of the differences between a long term winning trader and a burning star is that, rather than expect the distributions to stay the same, they adapt when the markets actions change in such a way that their method slips out of alignment.

 

If TA is useless then by definition Market Profile is useless!

 

TA (making trading decisions based on price and volume analysis) works for those that can make it work. I can't make MP work. Soultrader couldn't make patterns work. But that doesn't mean they don't work, it usually means we didn't do the work or get the teaching to make them work. It might also mean our brains have been wired incorrectly. But, TA can work for those that can make it work. That's my 2c

[torero 10]

I would have to agree with kiwi on many points here. Most traders one time or another use TA, but it's more than TA that cause them to lose, namely psychological makeup that cannot keep them disciplined or consistent enough to find out if TA really works or not. Most also don't make a carefully laid out plan to test out their TA-based strategies to make sure they work or not. But I think the most important factor is that most don't know how to use TA properly. In the end, they interpret them to fit their beliefs, exactly as kiwi says, "wired incorrectly". This is the biggest hurdle to overcome, not TA itself.

[Kiwi 16]

  Lopen said:

Im still new to technical analysis but would like to know if this really works? This whole concept seems to work just because traders believe in it.

Sorry, I forgot to answer the original question. Nice to see your agreement Torero, I had read a number of your posts and found myself nodding while reading so I suspect our market views are not dissimilar.

 

1. Elements of technical analysis are reinforced because other traders believe in them. Examples are most forms of support and resistance including prior swings, mas and fib ratios. So the more users then the more support there will be - but this doesn't say that the original observations, study and testing were wrong just that reinforcement helps.

 

2. Elements of technical analysis are damaged because other traders believe it it - sooner or later people figure out what the failure of a particular ta style looks like and will either fade the style, build on the failure or both. You see this with market profile enthusiasts who will perhaps short resistance at the hva but if it fails will jump on long to ride the failure. Failures can be some of the very best trades. Good TAs use both success and failure structures to their advantage as often as possible.

 

So things work both ways. The key for a trader is (IMHO) to take some ideas that appeal to them, observe them in real time, test them, build trading rules, test them, and then make some money. Then over time you expect that the two factors above (and others) will distort market behaviours so you will need to evolve slowly (maybe you just have to have 1pt bigger stops this year than last year) or quickly if market character varies dramatically to continue to be profitable.

 

I trade HSI and adjust my trading slightly every day ... some days my standard stops will work perfectly. Other days they don't but by watching the first few trades I can tell whether the day will be characterized by larger retracements or not (if it is I buy further back from my signal and put my stop further back as well). That's Technical Analysis in Action (and Evolution in Action).

[Gav 10]

I am with Kiwi. He has done an excellent explaination. Just to add on.

TA doesn't fail a trader, trader fails himself. TA is useless, because the trader is not applying correctly, and unable to accept the fact that, it is playing with probability. We use TA to look for high probability entry/exit point. It is just that simple.

 

Have a profitable day.

[Anna-Maria 10]

  Gav said:

I am with Kiwi.

 

We use TA to look for high probability entry/exit point. It is just that simple.

 

 

Ditto, Kiwi's comments. Especially the points made in the 4th paragraph of that post.

 

The entry/exit points Gav speaks of are merely the map & signposts of price.

 

Sometimes those signs get a little blurred & alter course along the way. But I'd sure rather have a reference point to check my direction & rest stops than no map at all.

[jperl 11]

  Soultrader said:

 

Jerry, I want to ask you a question. Can you elaborate on your point of normal distribution? I would like to understand this concept a little better. Thank you

 

A good general discussion of the Normal or Gaussian distribution can be found here:

 

Normal distribution - Wikipedia, the free encyclopedia

 

This is the type of statistical distribution that most TA users assume their TA rules for entry and exit will follow when they do back testing of their rule based trading plan. Unfortunately, most TA users never check this. If they did they would be shocked to discover that their TA rules don't fit a NORMAL or Gaussian distribution of results. The reason for this is quite obvious. The data themselves used to generate the rules, don't follow a Gaussian distribution, so nothing derived from it will either.

 

The normal distribution is what also occurs on what MARKET PROFILERS call a NORMAL DAY. Market profile is a subset of the volume or price histogram. On a NORMAL DAY, the volume histogram looks like a NORMAL distribution function, hence the name NORMAL DAY.

 

One of the important characteristics of a NORMAL DAY is the symmetry of the trading volume about the peak in the distribution (the point of control or POC). You can easily tell when a NORMAL DAY is occuring, or when a day is approaching a symmetric distribution (Gaussian or not), by computing the Volume Weighted Average Price (VWAP). When

 

VWAP=POC we have a symmetric distribution of traded volume.

VWAP>POC we have a skewed distribution of traded volume data toward higher prices.

VWAP<POC we have a skewed distribution of traded volume data toward lower prices.

 

Knowledge of the VWAP and its dynamic then has some important consequences for price action even when the distribution function cannot be analytically written down.

 

I dont' have the room here to go into all of the consequences of the VWAP.

At some point perhaps I will contribute and article about it.

JERRY

[drk1t 10]

TA seems pretty valid to me, I watch the charts, the trends are established, then the stock breaks the trend or it doesn't. That's about it in a nut shell. You can watch the level II and see the bid and ask volume change as it nears the R&S barriers, if it goes through then it's a new ball game until a new trend is established. Think of it like poker, you are delt a hand and then decide what might be best to do with it, same thing when you buy a stock. Some stocks I follow will drop about a certain amount and present a buy or get ahead of themselves and that's a sell, usually, sometimes etc. I look for leading indicators for the sector to help me decide. Then there is Buffet..... if I had his brains and intuition I could be an investor instead of a trader.

[phil895 10]

I think TA is a very good trading system, for this I must also include concepts that are technical; historical patterns, and price distributions... not just price and volume alone. I used TA almost exclusively sometimes, and the results are much better than FA for short term tradings. For long term setups, it will be another different story. I also find that engineering and math backgrounds are better at TA and economics and accountants are better at FA. When you hear failure rates it's usually from those outside the two academic backgrounds, this doens't mean that engineers and business people are better but they can learn to trade faster, and the success rates are much higher than the rest...

[Soultrader 12]

  jperl said:

A good general discussion of the Normal or Gaussian distribution can be found here:

 

Normal distribution - Wikipedia, the free encyclopedia

 

This is the type of statistical distribution that most TA users assume their TA rules for entry and exit will follow when they do back testing of their rule based trading plan. Unfortunately, most TA users never check this. If they did they would be shocked to discover that their TA rules don't fit a NORMAL or Gaussian distribution of results. The reason for this is quite obvious. The data themselves used to generate the rules, don't follow a Gaussian distribution, so nothing derived from it will either.

 

The normal distribution is what also occurs on what MARKET PROFILERS call a NORMAL DAY. Market profile is a subset of the volume or price histogram. On a NORMAL DAY, the volume histogram looks like a NORMAL distribution function, hence the name NORMAL DAY.

 

One of the important characteristics of a NORMAL DAY is the symmetry of the trading volume about the peak in the distribution (the point of control or POC). You can easily tell when a NORMAL DAY is occuring, or when a day is approaching a symmetric distribution (Gaussian or not), by computing the Volume Weighted Average Price (VWAP). When

 

VWAP=POC we have a symmetric distribution of traded volume.

VWAP>POC we have a skewed distribution of traded volume data toward higher prices.

VWAP<POC we have a skewed distribution of traded volume data toward lower prices.

 

Knowledge of the VWAP and its dynamic then has some important consequences for price action even when the distribution function cannot be analytically written down.

 

I dont' have the room here to go into all of the consequences of the VWAP.

At some point perhaps I will contribute and article about it.

JERRY

 

Thank you Jerry. I have never used this reference point but sounds very interesting. I will definitely look deeper into this.

[NoodlyJames 10]

  drk1t said:

Some stocks I follow will drop about a certain amount and present a buy or get ahead of themselves and that's a sell, usually, sometimes etc. I look for leading indicators for the sector to help me decide. Then there is Buffet..... if I had his brains and intuition I could be an investor instead of a trader.

 

I'm new here (obviously), although I have a lot more experience as a value investor. I've (at best) dabbled in TA and that's what I'm here to learn. The thing with Buffett (yes, he's a genius and he he has great intuition) is that he has brass balls and he doesn't care what happens to the price. Somehow, he is able to turn off the part of his brain which most of us give into. That fear and emotion which occur when a stock price drops 50% prompting us to cut losses only to watch the price turn around in 10 minutes (or a year)

 

I can find good companies cheap (yay internet). I can even stomach losing money over the short haul in order to gain long term. (This isn't intended to be about me but that's where my diatribe is going.)

 

I think pure fundamental analysis is wasteful. I give away money when my "great company" loses 50% of its share price before turning around. :crap:How much more efficient would it be to find a great company and then use TA to find an appropriate entry point or exit point?This is where I hope TA will come in. I have no idea how mixing the 2 will work (hopefully better than beer and gin) but it'll be interesting to find out.

 

As I said, I'm at "dumbass" level in TA right now but this looks like a great place to learn.