Four Problems with Technical Analysis

Four Problems with Technical Analysis

Being a geek, it is only natural that I am primarily a technical trader. However, I have never been satisfied with the current state of technical analysis (TA) due to lack of widespread, rigorous scientific approach to this subject. Here are four major problems with technical analysis see:

1st Classic reading scheme is too subjective:

"It is a rising wedge of course!"

"Err, that is head and shoulders top kind of embedded in it ... or something like that."

"Actually, I think it is the channel uptrend line, which is only part of a larger consolidation of diamond formation ..."

Yeah, right. The problem here is that human beings tend to look for patterns and more patterns that chartists "define", the more likely that one or more of them will appear in the table. No confirmed uptrend chart? What is a reverse head and shoulders? No? Well, both the rising or falling wedge flag, or maybe a cup with handle, rounded bottom or double top? Get the idea? If you can not find a pattern, just keep inventing new models until one appears on your lists. This is not useful, and the problem is exacerbated by the fact that most of the "models" in the classical chart reading is not strictly defined. By this I mean that it will be difficult to write a computer algorithm that describes how to identify every possible example of the model.

One of the main research projects I've worked on over the past few years include a method of classifying and identifying chart patterns in rigorous way. This method, called "Bar Pattern Analysis" (BPA), consists of encoding the specific characteristics of price behavior, so that any action on the table has a unique "string" of the code that describes. In this way, there is never any doubt about what the model can be seen, all having the same sheet of music. I'm still working through some conceptual issues with this approach, and will write more about it in future articles.

2nd Several TA indicator "signals" are supported by research:

Technical analysis does not only consist of reading a classic pattern however. Many technicians understand the shortcomings of classical chart patterns I have discussed, and took a big step forward with the construction of indicators. Technical indicators like moving averages, MACD and RSI provide clear unambiguous signals such as moving average Crossovers, overbought / oversold levels and so on and helped to eliminate much of the "subjectivity problem" with technical assistance. However, not everyone agrees whether a given signal is bullish or bearish. Even when there is agreement, it is usually only on the basis of common beliefs about market behavior or evidence ("See? Williams% R flashed the oversold signal on GBP / USD here, and the price rose immediately after"). This is not to say that there is no real scientific research is made on technical indicators, but it is far from common practice. Much of my work involves using statistical analysis to determine whether the conduct of technical signal has given a significant correlation for future price movements.

3rd Technical analysis deals mainly with the direction:

There are certain chart patterns such as triangles and flags that should tell you, not only in the direction of future price move, but also how much the price will move. However, most of the TA just answer the question "up or down?" It is not enough. When you trade currencies in 2004, I was constantly setting my stops too tight, my goals too far, or vice versa. This experience made me realize that "up or down" is not only important information. Traders should answer questions like "Should I put a firm stop or wide stop in this situation?" and "I need to set my price target for the small but close, possibly, profit, or larger but far less likely to get?" In my research in exchange rate behavior, trying to design my research efforts to include not only the question that way, but the question of how, as well.

4th The effectiveness of the indicators change as market behavior changes:

This is a conjectural model of how markets work that I'm studying right now. By "conjectural model" I just mean that this theory makes logical sense, but no trace of evidence to support it yet. The general idea is that the composition of the "mob" who is currently involved in active trading in financial instruments change over time as some people to stop trading it and others to start trading it. Every trader has their own individual style and composition of the "crowd" changes gradually over time, the behavior of the price will change its characteristics as well. I suspect that this is an evolutionary process, not a revolutionary one. For any given period of time however, the price behavior will have a certain "personality", a phenomenon I've seen mentioned by many traders.

As a result, I believe there are actually no "good" or "bad" indicators. There are only indicators that are currently working for a market and others are not. One constant challenge for retailers is to determine which is which, and to update their trading strategies accordingly. Some of my current research centers around creating tools that allow retailers to do this. Instead trader saying, "Well, I used a combination of moving averages and RSI" and so on, my vision is that retailers will be able to say, "I use whatever indicators you happen to work best at the moment depending on I m trading market. "


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