Technical Analysis For Trading

Technical Analysis For Trading

| Rich B. Clifford | Blog

Technical analysis for trading? We’re going to war with technical analysts. Well… It’s not like we’re picking up sticks and arrows… but nerd war. One where we point out how inconsistent they are and how math and physics is better. That kind of war.

Back in 2014, we asked 25 popular technically based traders to review a series of charts with technical formations and lines drawn on them. These included support / resistance lines, RSI indicators, volume metrics and a number of other options popular at the time.

We asked a very simple question. “Is now a buying opportunity or a selling opportunity?”

Going into this experiment, we expected to get some consensus… perhaps even a clean sweep where everyone came to the same conclusion. Why wouldn’t we? These indicators are supposed to be clear and consistent and definitive, right?  … No.Of the 25 traders we surveyed, 13 said now was a good time to buy. The other 12?  They suggested the charts indicated a selling opportunity.

We would conduct the study again but that would mean having to talk to technical analysts again… and no one needs that. (Side note: after review, all 25 of those surveyed back in 2014 are no longer trading. More on that later.)

So why does technical analysis for trading means something different to everyone?

The answer is simple. Confirmation Bias.

Confirmation bias occurs from the direct influence of desire on beliefs. When people would like a certain idea or concept to be true, they end up believing it to be true. They are motivated by wishful thinking. This error leads the individual to stop gathering information when the evidence gathered so far confirms the views or prejudices one would like to be true.

The real problem with technical analysis is traders end up seeing what they want to see. Nowadays, every low level forex trader with access to Microsoft Paint thinks he knows the market. Lines are drawn over averages, peaks are connected, drawdowns are highlighted, and anything that looks a bit like it could be a pattern without actually following any of the mathematical reasoning also gets a squiggle – confusion abounds.

There is a reason brokerage platforms provide free charting and endless technical indicators you can use. These tools get you to trade more frequently, not more profitably. As the saying goes, “when you’re a hammer, everything looks like a nail.” So when you’re bullish, all your indicators look like now is a good time to go long.

You might say, “Ok, but that’s not me. I meticulously analyze charts and follow rules. I can be objective and …

No, not according to the results. The average day trader’s live span is 3 weeks. In addition to that, only 1% of traders show a profit net of fees.  No other “profession” absorbs people’s money faster or more consistently than day trading or trading based on technical indicators. Honestly, your odds at a casino are significantly better, so maybe now is a good time get some real help with trading or just go play roulette.

So why do traders think they can deposit funds in an account, look at some charts for a few minutes and start pressing buttons to generate results?

This brings up another issue entirely but one that is not totally separate from technical analysis for trading. There seems to be no other profession or hobby where one is expected to perform well on their first day on the job.

Most new traders simply think they can “figure it out.” They deposit funds in an account, sit down in front of charts (most of which they have no idea how to read) and begin pressing buttons… expecting results. Others get convinced these indicators they are being fed have some meaning and discernability (they don’t). The sad reality to both assumptions is they are just completely wrong. No one would expect an individual in any other profession to show up on day one and excel… so there is no reason to believe a trader on his/her first day or even during their first year would excel either.

And there lies the sad truth to technical analysis. Nearly all of it is grounded in assumptions based on a previously held bias that appeals to new traders looking for an edge. The other set of tools that don’t fit within this category are there to increase your trading frequency. In reality, technical analysis is more often the reason why traders only last an average of 3 weeks than it is why those who show a profit only represent 1% of the trading universe.

What can be done about this bias in technical analysis for trading?

Trading for results is most successfully accomplished by being systematic and unemotional. As one successful trader often says, “have a plan and stick to your plan.” This may mean following a plan that prompts you to buy when it “doesn’t feel right.” Or the plan may say to close a position you think “still has room to run.” Remember, the market does not care what you think. The rules you set up for yourself are there to overcome that emotion. Also, use tools that are not driven by an underlying bias. Use tools that don’t require some level of interpretation to determine action. Use tools that are definitive, clear and actionable. With anything else, you’re simply guessing. Don’t fall into the trap thinking these stats above don’t apply to you. They do. But they can be avoided by doing what the 1% of successful traders do.

Want some help in coming up with a rules based strategy entirely based on math and physics formulas?

Learn more about fractalerts and how we get rid of the influence of emotions on trading? Fill in the form on our home page and a member of our team would be happy to give you a call or engage via email. Follow our trades. Leave the math to us.

To simply learn more about our process, check out our “The Science” page.