A significant portion of the trading world denounces technical analysis as a superficial study of charts and patterns without any concrete, conclusive, or profitable results. (Related: Analyzing Chart Patterns: Introduction). Some misconceptions about technical analysis are based on education and training (for example, a trader trained on using only fundamentals may not trust technical analysis at all). Some myths are based on experience (for example, the incorrect use of technical indicators leading to losses).
However, any way you slice the pie chart, a significant number of traders are reliably profiting using technical analysis. In this article, we will discuss and debunk some myths about technical analysis.
- Technical analysis is only for short-term trading or day trading: It is a common myth that technical analysis is only appropriate for short-term and computer-driven trading like day trading and high-frequency trades. The fact remains that technical analysis existed and was practiced even before computers were common. Analysts used to manually plot graphs and charts over days, weeks, and months to spot technical trends. Even today, traders use concepts like 20-day moving average (MA) crossing over 50-day MA for long-term investing. (Related 10 Steps To Becoming A Day Trader)
- Only individual traders use technical analysis: It is simply not true that only individual traders use technical analysis. Large hedge funds and investment banks make ample use of technical analysis. The global investment banks have dedicated trading teams which use technical analysis. High-frequency trading (HFT), which has become incredibly popular in recent years, is heavily dependent on technical trends.
- 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. Books covering interviews of successful traders have cited 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 profiting solely from technical indicators.
- Technical analysis is quick and easy: The Internet is full of promotions for short courses in technical analysis that guarantee trading success. Though many individuals enter the trading world by placing their first trade based on simple technical indicators, continued success in trading requires in-depth learning, discovery of new patterns, good money management, and capital allocation skills. It requires dedicated time, knowledge and attention. (Related Build a Profitable Trading Model In 7 Easy Steps)
- Ready-made technical analysis software can help traders make easy money: Unfortunately, this is not true. There are many online ads for costly software that claim to do all your analysis for you. In addition, less-experienced traders sometimes confuse technical analysis tools in broker-provided trading software for trading models that will guarantee profit. Though technical analysis software provides insights about trends and patterns, they don’t necessarily guarantee profits. It’s up to the trader to correctly interpret trends and data. (Related The Best Technical Analysis Trading Software)
- Technical indicators can be applied across all markets: Specific asset classes have specific requirements. Equities, futures, options, commodities and bonds all work differently. There may be time-dependent patterns like high volatility in futures and options nearing expiry, and seasonal patterns in commodities. Don’t make the mistake of applying technical indicators intended for one asset class to another. (Related The Top Technical Indicators For Options Trading and The Most Important Technical Indicators For Binary Options)
- Technical analysis can provide very accurate price predictions: Many novices expect recommendations from technical analysts or software patterns to be 100 percent accurate. For example, inexperienced traders may expect a prediction as specific as, “stock ABC will reach $62 in 2 months.” However, experienced technical analysts usually avoid quoting prices so specifically. Rather they tend to quote a range such as, “stock A can move in the range of $59-$64 in the next 2 to 3 months.” Traders betting their money on technical recommendations should be aware that technical analysis provides a predictive range, not an exact number.
- The winning rate in technical analysis should be higher: It’s a common perception that higher percentage of winning trades is needed for profitability. However, that is incorrect. When conducted with the correct profit levels in mind, a low number of winners can lead to profit. Let’s say that on average, Peter makes 4 winning trades out of 5, while Molly makes 1 winning trade out of 5. Who is more successful? Most people would say Peter, but this may be incorrect. Proper trade structuring allows profitability in the long run, even with fewer winners. With $20 per winning trade, $100 per losing trade and 4/5 = 80% success rate, Peter effectively makes (0.8*$20-0.2*$100) = -$4 loss. With $100 per winning trade, $20 per losing trade and 1/5 = 20% success rate, Molly effectively makes (0.2*$100-0.8*$20) = +$4 profit. Losing small multiple times and profiting big a few times can still be overall profitable trade strategy if the trades are structured properly.
The Bottom Line
Technical analysis is one of the oldest trading concepts and has become exponentially more advanced with the use of super fast computers. Many of the present-day advanced trading systems running on high-end computers at large trading firms are based on technical trends. Technical analysis can be a trader’s cornerstone strategy or one of many useful data points.