Trading Strategies and ideas

4 Reasons Why Technical Analysis Doesn’t Work For Most People

Reason 1: Technical Analysis cannot predict the future

People who say Technical Analysis does not work think TA is a tool to predict the future. I must admit I was one of them.

Obviously, no one can predict the future.

What people misunderstand is that TA is a tool to provide “actionable points” in the future and not to predict the future. Let me explain by using a TA that I did recently.

The chart below is an SPX daily chart. There is a red “Daily uptrend line” drawn using the daily chart. As you can see the uptrend is not perfect because two bars on July 13th and July 14th went below the trend line.

However, for some mysterious reasons, the market decided to follow the trend again and jumped up on July 15th. So in the end, the uptrend did not break.

For TA naysayers, this is a big no no. The trend was broken. TA is hindsight bias. TA did not work.

TA spx 7.22.2022

Based on my observations, TA tends to work better when there are no major events because the market is primarily driven by people who use TA in the short term (day traders, swing traders). When enough people look at the same thing thinking the same way, the market would move that way. But when additional data (an event) is fed into it, everything could change.

In fact, there are so much data getting fed into the market, and people who use TA to trade are only a portion of it. When it went below the trend line on those couple of days were due to CPI data and bad earning reports. Obviously, those events caused a large market reaction.

If one did a TA analysis on those couple of days at that time, one would say the trend was broken due to the events at that point in time. Then for some miracle reasons, the market decided to continue the trend. Sometimes, looking at a shorter timeframe could answer that question but again, a lot of times the market just does what it wants.

What’s important is what actions were taken based on what TA was telling us when the trend was broken and when the market went back to the trend. Not how accurate TA was or is.

So what does that mean? It means you could scale back your positions or adjust the portfolio based on that market-generated information on those days when the trend was broken. Then when the market went back to follow the trend again, adjust the positions again based on that new market-generated information.

Reason 2: Technical Analysis is too complicated

There are so many technical studies and indicators available for Technical Analysis. For example, the Thinkorswim platform offers more than 400 technical studies (image below).

TOS number of studies available

One of the most commonly misunderstood ideas for beginners that I noticed is that, when it comes to tools used for TA, one has to use as many of them as possible to get the most accurate result.

This is obviously not true.

It does not matter how many studies or indicators you use, the market just does what it does, it will disregard the trendlines or support/resistance lines.

After testing out a lot of indicators and different technical analysis methods, I came to realize keeping it simple is the best. At the end of the day, these tools all tell the same thing but just in different ways.

It is true that some tell it better than others, but the message is the same at the end of the day.

I now keep it very simple by primarily only using trendlines, Simple Moving Average, and support and resistance lines.

Reason 3: Technical Analysis doesn’t work on the stocks I picked

There are a couple of explanations for this.

It’s all about the market! Not individual stocks.

Most beginners don’t understand that they need to monitor the market indices rather than just trade and focus on individual stocks. If it’s a bull market, the stock you picked will go up and if it’s a bear market, the stock will go down. No matter how good or bad technically or fundamentally the stock is, it will be moved by the overall market conditions.

Thinly traded stocks are the worst

If a stock is thinly traded, especially stocks that are not listed on one of the major indices, technical analysis doesn’t work very well. The stock price is moved by people (or machines controlled by people) who trade it. So if not too many people are trading it, there won’t be any obvious moves or patterns created by the trading activities in the first place.

Reason 4: Using the wrong timeframe with the wrong studies/indicators

Some Technical analysis studies and indicators are better for shorter timeframes than longer ones and vice versa.

For example, I personally don’t do day trade or short-term swing trades so I don’t use an indicator such as VWAP that considers the volume of the stock traded for the day.

I don’t draw trendlines or support/resistance lines on the 1-minute or 5 minutes chart regularly because I don’t trade in those timeframes.

It’s important to know what your trading style is. Once you figure it out, everything else will just fall into place.

Any Other Reasons?

What do you think? Are there other reasons that I am missing? Let me know in the comment below.

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