Technical analysis is a way that traders and investors predict future market trends and security prices. It can be a successful way to find investment opportunities that will be profitable in the future. However, there are situations where technical analysis does not work.
Technical analysis fails in five situations: for long-term trading and investing, when investors want specific predictions, when unexpected or outside events affect the market, when the trader is not educated on technical analysis, and when you rely solely on technical analysis software.
This article will explain what technical analysis is, the five situations where it fails, and what alternatives to technical analysis exist. There are also resources in the article that you can use to learn more about technical analysis and its two alternatives.
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Table of Contents
What Is Technical Analysis?
Technical analysis is a type of trading strategy where you study current and past market trends to determine future trading opportunities. Investors who use technical analysis expect that past trends can predict future market trends.
Technical analysis is used to evaluate many types of markets, including stocks, futures, gold, cryptocurrencies, and more. The only requirement is that the asset must have historical data for you to analyze. Otherwise, you will not be able to use technical analysis.
When using technical analysis, there are many market indicators that you will analyze, including price trends, market volume, moving averages, and chart patterns. You can look at one of these indicators or multiple depending on how in-depth your analysis is and what you are trying to predict.
5 Situations When Technical Analysis Does Not Work
Although technical analysis can be a good method for predicting stock market opportunities for specific companies, it does not always work. There are five main situations where technical analysis will fail. They are detailed below, so if you expect any of these events or situations, technical analysis will not work for you.
Long-Term Trading and Investing
Technical analysis is best for short-term trading and data analysis. The data that investors analyze when they use technical analysis is over a short period.
You might ask, why not just use technical analysis over a longer period of data? The analysis with long-term data will not be as accurate because of the higher number of fluctuations. The more the indicators change, and the longer the period you have, the more data there will be, and the less accurate that data will be at predicting the future of the securities.
When Investors Want Specific Predictions
With technical analysis, you will not be predicting specific outcomes for stock prices. You will be looking at estimated ranges of stock prices.
For example, you will not predict that XYZ Stock will be priced at $90 in forty-five days. Instead, you will have predictions like XYZ should increase in price to approximately $85-95 in the next month or two.
Technical analysis is never one hundred percent accurate, so if you have a predicted range for both the price change and the time frame, you have a better chance of being correct.
When Outside Events Affect the Entire Market
Technical analysis does not work if the entire market is trending in the same direction. Whether it is a positive or negative fluctuation, your predictions will not have a significant change that is inconsistent with the market trend.
For example, if an unexpected political or economic event has the stock market trending in one direction, the expectations that you had from your technical analysis will be irrelevant. They will not be true even if your analysis determines that the market should be trending in the opposite direction or if you expected the market to have a bigger or smaller change than it does.
You Are Not Educated on Technical Analysis.
Anyone can use technical analysis. Individual traders, hedge funds, and investment banks all use technical analysis to help them in their trading decisions. However, all of these people are highly qualified and educated on technical analysis.
If you try to use technical analysis as an amateur with no understanding of it, or practice, you will fail.
Technical analysis is not easy to do, and it takes a lot of education to do it properly. You also need to put the time necessary to understand and analyze the market’s data. Without patience and knowledge, your attempt at technical analysis will not be successful.
There are some great books that you can use to learn more about technical analysis. First, you can read Technical Analysis of Financial Markets: A Comprehensive Guide to Trading Methods and Applications from Amazon.com. You will learn how to apply technical analysis to multiple investment types, including futures and the stock market. The book will teach you how to understand financial indicators and how they apply to technical analysis.
For another, simple to understand book, Technical Analysis for Dummies from Amazon.com will teach you all the basics of technical analysis. You will learn how to understand important indicators, read the market sentiment, why charting is important in technical analysis, and interpret data to make informed decisions.
You Rely on Technical Analysis Software
Many investors think that they can rely heavily on technical analysis software for their predictions. You cannot rely solely on software because, while technical analysis software can provide data for you, it does not mean that the outcome will make you a profit.
You will still need to analyze the data that this type of software provides. If you can’t analyze it or interpret it wrong, you can easily lose money.
Additionally, some bad software out there may not provide you with all of the data you want or need. If you miss key pieces of information, you can misinterpret an analysis and invest in the wrong securities.
Alternatives to Technical Analysis
There are two alternatives to technical analysis: fundamental analysis and quantitative analysis. If you are in one of the situations above where technical analysis will fail, you could try one of these types of analysis.
First, fundamental analysis measures the intrinsic value of a security, a company, or the market. It is most often used for long-term investments and works when you consider the entire scope of the company or market you analyze, including all of their assets and current value.
You can learn more about fundamental analysis with the book Getting Started in Fundamental Analysis from Amazon.com. You will learn how to analyze financial statements, how fundamental analysis can be used with other trading strategies, and how you can find the information you need to do a successful analysis.
The second alternative approach is the qualitative analysis which involves analyzing financial ratios and calculations to predict the future value of securities and markets. Qualitative analysis is often used on top of the other two approaches to accompany the data and predictions from those methods.
To aid you in qualitative analysis, you can use the Quantitative Analysis Value Investor Notebook from Amazon.com. Using this book, you can track your analysis, compute and keep track of financial ratios for the companies and markets that you analyze, and add any extra notes that you have.
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Conclusion
Many investors and investment companies use technical analysis. It is great for the short-term analysis of securities with a lot of historical financial data if you want to predict future trends.
However, it does not always work, and the five situations detailed in this article are the most common times that it fails. You can use fundamental analysis or quantitative analysis in these situations, and they will likely work better.
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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