Technical analysis seeks to predict the future movement of a stock. Some traders find great success with this method, but most people consider it to be nonsense. What most traders don’t realize is that technical analysis is a form of science.
Technical analysis is scientific, as it’s an applied social science with economic underpinnings. Its primary tenet is that history repeats itself, aiming to predict future price movements by looking at past patterns. Its various indicators are scientifically sound and can be profitable.
This article will discuss whether technical analysis is voodoo or entirely scientific. We will also review why technical analysis is worth learning.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Is Technical Analysis Voodoo?
Technical analysis is not voodoo. Some traders agree that technical analysis is taboo for those who don’t fully understand the process.
Generally, technical analysis is considered a trading discipline that uses charts to predict whether a stock’s price will rise or fall. Profitable trading with technical analysis requires investors to quantify entries and exits while minimizing the risk of losses.
However, this form of analysis has its faults, and many traders fail when using technical analysis. For this reason, most investors avoid the approach altogether. But new traders should investigate why technical analysis fails some investors before ruling it out as voodoo.
What Are Some Reasons Why Technical Analysis May Not Work?
The most common reason why technical analysis may fail is that it does not consider the underlying social, political, or economic conditions of the company offering the shares. Therefore, a chart reading can give false indicators of a company’s status, leading to financial losses for a trade.
Many traders also make the mistake of using automatic trading software for their analysis. While these programs are convenient, they do not guarantee profit and can be inaccurate. Consequently, it is best to avoid them or use them in combination with an established strategy.
But these common failures are avoidable.
Investors should consider supplementing technical analysis with another trading technique. The most successful traders use this formula to reduce their risk and increase the chance of profits.
Is There a Science Behind Technical Analysis?
In short, technical analysis is an applied social science. This investigative method studies the financial markets from three different aspects:
- Psychology
- Economics
- Political science
Moreover, technical analysis considers multiple characters of stock trading, including:
- Past performance
- Trading volumes
- Current price
Most people think technical analysis is a fast and straightforward process, but skilled analysts perform in-depth tests to draw conclusions based on technical analysis. Experienced traders use the following indicators, among others, to get relatively accurate results:
- Moving averages
- Cycle regressions
- Relative strength index
- Regressions
- Inter-market relations
- Intra-market price correlations
Moreover, there are various tested methods involved in technical analysis.
The Dow Theory for Stock Trading
This theory comes from Charles H. Dow and is based on six principles that have stood the test of time and remained relevant to today’s trading scene. Successful traders consider the following principles to be scientific because they provide a deeper understanding of stocks and their movement:
- There are three different types of movement in the stock market.
- Trends have three distinct phases.
- The stock market discounts all news.
- Trading volumes must confirm market trends.
- Market averages should confirm each other.
- Market trends only end when there are definitive signals.
Any trader that implements these principles into their technical analysis uses tested and proven methods, not voodoo.
Candlestick Charting for Stock Trading
Homma Munehisa developed candlestick charting during the 18th century. This method is favored among beginner traders for its simplicity. Traders essentially use a bar-style chart to predict price movement. Ultimately, the candlesticks indicate price actions by comparing former patterns of activity to the current trends.
This method is based on the scientific principles of frequency and historical repetition.
The Wave Principle for Stock Trading
Ralph Nelson Elliot invented this principle in 1938. This theory dictates that market investors move from pessimism to optimism causing reversals in price movement. It uses a three-wave structure.
Some experiments have shown that this analysis strategy is about 84% accurate. Voodoo and pseudosciences are not known to provide such accuracy. Only scientifically sound methods could give investors such a high chance of winning at a consistent frequency.
Does Technical Analysis Work?
Technical analysis does work, and it can be incredibly profitable when done well. Many successful traders profit solely from technical analysis.
However, most investors lose money with this method because they do not follow the proper steps for developing their analysis strategy.
‘Trading With Rayner’ blog notes that every investor should follow these four steps for their technical analysis strategy:
- Read research papers to discover which indicators are most profitable.
- Copy the analysis strategy of science experiments and famous traders.
- Develop a personal strategy.
- Back-test your technical analysis.
Notably, where most traders fall short in technical analysis is neglecting to test their interpretation strategy. Going into the stock market without prior testing is one of the worst decisions an investor can make and usually ends in a financial loss.
Back-testing should be your top priority to succeed with technical analysis.
Is Technical Analysis Worth Learning?
Technical analysis is worth taking the time out to learn. It is arguably one of the most innovative analysis tools to master.
Stern notes that the stock market never reflects the actual value of a share. The market shows what various investors think the stock is worth. For this reason, technical analysis is efficient. As mentioned earlier, technical analysis is a social science, making it perfect for a socially influenced market.
Technical analysis is also worth learning because it is highly accurate. Like the other forms of forecasting, the prediction is sometimes wrong. But in most cases, a skilled analyst can predict price movement with overwhelming correctness.
There are also other perks to using technical analysis.
Pros of Using Technical Analysis
According to TradingView, technical analysis has the following advantages:
- It is logical.
- All the necessary information is readily available.
- Investors can use it across multiple markets—stocks, forex, crypto, etc.
Moreover, technical analysis is versatile. It can be used for day trading and long-term investments while being accurate in either instance.
Traders consider technical analysis to be the easiest investigation method because it does not require the investor to search for company documents. Often, all that is needed is a thorough evaluation of the price charts.
Finally, technical analysis can provide a predictive range without the need for several trading tools. Contrary to popular belief, not all technical indicators need to be aligned for an accurate conclusion. Investors can find success even if they only choose the indicators that they are comfortable with using.
Technical analysis can be helpful, but it has its disadvantages as well.
Cons of Using Technical Analysis
The most significant downside of technical analysis is that it doesn’t consider geopolitical factors. Seeing that technical analysis does not require staying updated with the news, many traders will use chart indicators contrary to public perception and lose money.
Another disadvantage is that this method requires a lot of dedicated time to grasp the concepts properly. Thus, traders without spare time will experience challenges.
Being successful when trading with technical analysis also requires:
- In-depth learning
- Discipline
- Practice
- Good money management skills
Therefore, if you fall short in any of these areas, technical analysis will fail you.
Lastly, technical analysis cannot give exact numbers. Therefore, traders must use a predicted range. A price range can be inconvenient for investors who want straightforward readings.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
Technical analysis has a bad reputation in most trading circles. Still, it deserves to be a respected art form and scientific method. Many traders are incredibly successful in using candlestick charting and find it the easiest. But there are other strategies and many indicators that investors can use for a successful chart reading.
The Traveling Trader has a 20-minute video explaining technical analysis and its usefulness. Consider using his tips to implement technical analysis into your trading strategy:
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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