Debunking 8 Myths About Technical Analysis


Some traders and investors denounce technical analysis (TA) as a cursory study of charts and patterns with no concrete, conclusive or profitable results. Others believe that it is a kind of Holy Grail that, once mastered, will generate considerable benefits. These opposing views 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 the exclusive use of fundamentals may not trust technical analysis at all. But that doesn’t mean someone 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 does not mean that the method is necessarily bad; the person may just need more practice and training. Other myths are perpetrated by marketing, which promises riches overnight if a simple indicator is bought and used. It is rarely that easy.

Key takeaways

  • Technical analysis tries to capture market psychology and sentiment by analyzing price trends and chart patterns looking for potential trading opportunities.
  • Contrary to fundamental analysis, technical analysts do not necessarily care much about the companies that are behind the stocks they trade or their profitability.
  • Some believe that technical analysis is the best way to trade, while others claim that it is wrong and lacks a theoretical basis. Here we debunk some myths on both sides of the debate.

Myths of technical analysis debunked

Here are eight common myths of technical analysis. Read opposing views on why these myths are simply not true.

1. Technical analysis is only for short-term transactions or daily transactions.

It is a common myth that technical analysis is only appropriate for short-term, computer-controlled operations, such as daily operations and high-frequency operations. 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. Traders use technical analysis on all time frames, from 1 minute charts to weekly and monthly charts.

2. Only individual traders use technical analysis.

While people use technical analysis, hedge funds and investment banks also make extensive use of technical analysis. Investment banks have dedicated trading teams that use technical analysis. High-frequency trading, which encompasses a significant amount of trading volume on stock exchanges, relies heavily 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 a significant number 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 who benefit solely from technical analysis.

4. Technical analysis is quick and easy.

The Internet is full of technical analysis courses that promise business success. Although many people enter the world of trading placing their first trade based on simple technical indicators, continued success in trading requires deep learning, practice, good money management, and discipline. It requires dedicated time, knowledge, and attention. Technical analysis is just a tool, just a piece of the puzzle.

5. Out-of-the-box technical analysis software can help traders make money easily.

Unfortunately, this is not true. There are many advertisements online for cheap and expensive software that claim to do all the analysis for you. Also, less experienced traders sometimes confuse the technical analysis tools in the trading software provided by the broker with trading models that will guarantee profit. Although technical analysis software provides information on trends and patterns, it does not necessarily guarantee profits. It is up to the trader to correctly interpret the trends and data.

6. Technical indicators can be applied in all markets.

While this may be true in many cases, it is not true in all cases. Specific asset classes have specific requirements. Stocks, futures, options, commodities, and bonds have differences. There may be time-dependent patterns, such as high volatility in expiring futures and options, or seasonal patterns in commodities. Don’t make the mistake of applying technical indicators targeting one asset class to another.

7. Technical analysis can provide very accurate price predictions.

Many beginners expect technical analyst recommendations or software standards to be 100% accurate. For example, inexperienced traders can expect a prediction as specific as, “ABC shares will hit $ 62 in two months.” However, seasoned technical analysts generally avoid pricing so specifically. Rather, they tend to trade a range like, “Stock A could move in the $ 59 to $ 64 range in the next two to three months.” Traders who bet their money on technical recommendations should be aware that technical analysis provides a predictive range, not an exact number. Technical analysis is also about likelihood and likelihood, not guarantees. If something works most of the time, even if it doesn’t work all the time, it can be very effective in generating profit.

8. The win rate in technical analysis should be higher.

It is a common myth that it takes a high percentage of winning trades to get profitable. However, that is not always the case. Suppose 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 really won’t know until we get more information. Proper business structuring enables profitability even with few winners. Profitability is a combination of rate of profit Y risk / reward. If Peter wins $ 20 from his winners but loses $ 80 on this loss, he ends up with $ 0. If Molly wins $ 50 on his win and loses $ 10 on his losses, he takes $ 10. She’s better, even with fewer wins. .

The bottom line

Technical analysis provides a wide variety of tools and concepts for trading. There are successful traders who don’t use it and there are successful traders who do. Ultimately, it is up to each trader to explore technical analysis and determine if it is right for them. It does not guarantee instant profit or 100 percent accuracy, but for those who diligently practice the concepts, it provides a realistic chance of business success.

www.investopedia.com

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Mark Holland

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