No, that title is not a joke. It’s an actual fact. Technical analysis is never wrong. Never. But the people using it, are nearly always wrong.
Almost everyone who decides to go down a trading path, at some point (usually early in the process) encounters technical analysis. If by some miracle you’ve avoided this, technical analysis (TA, for short) is the process of applying various mathematical measurements to aspects of the movement of prices and/or volume, usually in an attempt to forecast where a price is likely to go in the future. Obviously the implications of this are that if you know where something is going to wind up, you can know exactly when to buy or sell it for maximum gain.
Fans of TA love their patterns, and there are an infinite number of ways to create these patterns. You can stick with the relationships of the price bars themselves (usually known as “candle patterns”), you can measure distances between things and ascribe significance to certain fractal relationships found in nature (Fibonacci sequences), you can believe that everything in life follows a specific set of cyclic movements or “waves” (Elliott Wave and other theories), you can simply look at averages of things over time, and when a shorter-term average crosses a longer-time average, believe it’s important. Heck you can even believe that the markets move due to the moon or to the alignment of other planetary bodies in the solar system!
And here’s the thing. Not a single one of these things, is ever wrong. No matter what you, or I, or anyone else thinks of technical analysis, it is never wrong. The trouble is that people completely misunderstand what they’re seeing with it, or assign importance or significance to things, that actually have none at all.
The average of two prices, say 300 and 200, is 250. So if you were to plot an average on a chart bar where the low was 200 and the high was 300, you would get a plot at 250. Is this important by itself? Of course not. Is the average wrong? Also of course not!
The 61.8% retracement of a particular “swing” in a stock price, might be $85. Is that meaningful by itself? No! Is the retracement wrong? Also no!
Mercury might be in retrograde, while Saturn is in Uranus (lolz), but does this matter to the price of steel? Of course not. Is the analysis wrong? Nope!
This is the problem with TA. People don’t actually have any reasoning for why any of these things, would matter. They attribute it to “natural law” or “divine forces” or whatever else they need to tell themselves, and then they proceed to make or lose money. When they make money, they “result” by saying “See, it worked! It was obviously a correct decision and a solid analysis!” And when they lose money, they either write it off as “Oh well obviously I made an error in my analysis!” or “The wave count was invalidated so we need to re-count it, the analysis can’t be wrong!” (and they’re right about that last part, ironically!). Or they throw up their hands and complain that “TA doesn’t work” when in reality, it was they, the human being, who had completely the wrong idea about the tool they were using.
TA can be useful for sure. Imagine you wanted to look at a recent downswing, and figure out at what point the people who bought the top might give up and bail out thereby enabling price to begin moving up again. You might decide that a 50% loss is probably reasonable, a 60% loss might shake out some of the more stubborn longs, and an 80% loss is almost sure to get them all out. And for this you could use a Fibonacci retracement to show you where those points are on a chart so you could keep an eye on them, and this is a perfectly useful reason to use such a tool. But it’s not predicting anything or telling you what to do. It’s not saying “Get long with everything you’ve got if we hit the 78.6% retracement!”
So by all means fellow trader, use technical analysis. But understand what it is and why you’re using it, and apply it when it actually makes sense to do so.
Until next time, good trading!
Jonathan van Clute
Community Manager, Trading Research Group