Some traders and investors condemned technical analysis (TA) as a superficial study of charts and patterns, without any specific, conclusive or profitable results. Others think this is a holy grail, once mastered, it will release considerable profits. These opposing views have led to misunderstandings about technical analysis and how it is used.
Technical analysis attempts to capture market psychology and sentiment by analyzing price trends and chart patterns of possible trading opportunities. Contrary to fundamental analysis, technical analysts do not necessarily care about the companies behind the stocks they trade or their profitability.
Some misunderstandings about technical analysis are based on education and training. For example, a trader who has been trained to use only fundamentals may not trust technical analysis at all. But this does not mean that people trained in technical analysis cannot use it for profit.
Other TA assumptions are based on bad experiences. For example, the wrong use of technical indicators often leads to losses. This does not mean that the method must be wrong; maybe the person just needs more practice and training. Unethical marketing may perpetuate negative sentiment. If you buy and use a simple TA indicator, you can be sure to get rich overnight. It’s rarely so easy.
Here are eight common technical analysis misconceptions — and why they are not true at all.
- Technical analysis (TA) attempts to capture market psychology and sentiment by analyzing price trends and chart patterns of possible trading opportunities.
- Many opponents of TA agree with the myth about this strategy.
- Common misconceptions about TA include that it is only used for day trading and only for individual traders.
- Other misunderstandings include the idea that TA is fast and easy, and that all decisions are made by software.
- Some people mistakenly expect TA to make accurate price forecasts, which are equally applicable in all financial markets.
1. Technical analysis is only applicable to short-term trading or intraday trading
Technical analysis only applies to short-term and computer-driven transactions, such as day trading and high-frequency trading. This is a common myth. Technical analysis existed and was practiced before the popularization of computers. Some of the pioneers of technical analysis were long-term investors and traders, not day traders. Traders use technical analysis on all time frames, from one-minute charts to weekly and monthly charts.
2. Only individual traders use technical analysis
Although individuals do use technical analysis, hedge funds and investment banks also use technical analysis extensively. Investment banks have dedicated trading teams that use technical analysis. High-frequency trading, which involves a large amount of stock exchange trading volume, relies heavily on technical concepts.
3. Low success rate of technical analysis
A look at the list of successful market traders with decades of trading experience will debunk this myth. Successful trader interviews enumerate a large number of traders who attribute their success to technical analysis and patterns. For example, Market Wizards: Interviews with Top Traders (Wiley, 2012) The author Jack D. Schwager interviewed many professionals who profit only from the use of technical analysis.
4. Technical analysis is quick and easy
The Internet is full of technical analysis courses that guarantee the success of transactions. Although many people enter the trading world by making their first trade based on simple technical indicators, the continued success of trading requires in-depth learning, practice, good money management and discipline. It requires dedicated time, knowledge and attention. Technical analysis is just a tool, only part of the puzzle.
5. Off-the-shelf technical analysis software can help traders make money easily
Unfortunately, this is not the case. There are many online advertisements for cheap and expensive software that claim to do all the analysis for you. In addition, inexperienced traders sometimes confuse the technical analysis tools in the trading software provided by the broker as a profitable trading model. Although technical analysis software provides insights about trends and patterns, it does not necessarily guarantee profits. The correct interpretation of trends and data depends on the trader.
6. Technical indicators apply to all markets
Although technical analysis can be applied to many markets, there are specific requirements for specific asset classes. There are differences in stocks, futures, options, commodities and bonds. There may be time-dependent patterns, such as high volatility in futures and options approaching expiration, or seasonal patterns in commodities. Don’t mistakenly apply technical indicators for one asset class to another.
7. Technical analysis can provide accurate price forecasts
Many novices hope that the recommendations of technical analysts or software patterns are 100% accurate. For example, an inexperienced trader may expect a specific forecast, such as “stock ABC will reach $62 in two months.” However, experienced technical analysts usually avoid making such a specific offer. Instead, they tend to quote a range, such as “Stock A may fluctuate in the range of $59 to $64 in the next two to three months.”
Traders who bet on technical advice should be aware that technical analysis provides a forecast range, not an exact number. Technical analysis is also about probability and possibility, not guarantee. If something is always effective, even if it is not always effective, it can still generate profits very efficiently.
8. The winning rate of technical analysis should be higher
A common misconception is that profit requires a high percentage of winning trades. However, this is not always the case. Suppose Peter wins four out of five trades, and Molly makes one winning trade out of five trades. Who is more successful? Most people would say Peter, but we don’t actually know until we get more information.Profitability is a combination of winning percentage and Risk/reward. If Peter made $20 from his winner, but lost $80 from one of his losses, then he would end up with $0. If Molly wins $50 and loses $10, she will take $10. Even with fewer wins, her situation is better.Even if there are only a few winners, a proper trading structure can be profitable
Technical analysis provides a large number of tools and concepts for trading. There are successful traders who do not use it, and there are successful traders who use it. Some people believe that technical analysis is the best way to trade, while others claim that it is misleading and lacks a theoretical basis.
Ultimately, it is up to each trader to explore the technical analysis and determine whether it is suitable for them. It does not guarantee instant profit or 100% accuracy, but for those who are diligent in practicing these concepts, it does provide a realistic possibility of successful trading.