The idea that you can predict future prices from a chart is an enticing one. And it draws in many non-professional investors because of its accessibility. But why do professionals seem to shun technical analysis?
Technical analysis is shunned by professionals because it disregards industry analysis and fundamental analysis, especially for long-term investment decisions. It also lacks a scientific basis and is mostly subjective. However, in the forex market, about 30% of pros use technical analysis.
So, it may be too much of a generalization to think all professionals shun technical analysis. But it does seem that technical analysis has a reputation problem. We’ll explore this in more detail below.
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Table of Contents
What’s the Problem With Technical Analysis?
The reasoning underlying technical analysis may be why some professionals aren’t believers.
It’s All in the Price — Or Is It?
One principle of technical analysis is that the price discounts all current information. That means corporate or industry-specific news is already in the price. So, too, economic, political, and other data.
Also, technical analysts believe the price is swift to reflect any new information. Putting it together, technical analysts don’t look at fundamentals.
In contrast, that’s precisely the kind of information a fundamental analyst looks at. Such information helps assess if an investment has more value than its current price.
Because fundamental analysts believe not everything is baked into the cake. There’s value out there if you can find it. And the way to do that is to analyze the fundamentals.
Most professionals making investment decisions have the training to use fundamental analysis. That will include analyzing financial performance. It will also include industry analysis, plus wider economic factors.
So, it’s no surprise such professionals have a natural bias towards fundamentals.
Price Action Develops Patterns — Or Are They Illusions?
Another essential belief in technical analysis is that history repeats. And that includes price action. That’s because buyers and sellers tend to repeat the behavior of previous buyers and sellers. It’s down to psychology.
So, by studying historical prices, you can see recurring patterns in the price action. And those patterns can help predict how prices will move next.
The problem with that is that it can be subjective. Technical analysis isn’t a science and is open to interpretation. And, while it may be easy to see a chart pattern in past price action, it’s trickier to spot it as it unfolds in real-time.
So, there’s ample scope for two people to see different things in the same pattern. It’s a bit like ambiguous images. For example, Rubin’s vase. Is it a vase or two men facing each other?
And, like those ambiguous images, if you look long enough, you can see both. In technical analysis, that can lead to confusion if the patterns are contradictory.
This subjectivity leads to some professionals questioning the value of technical analysis. That, of course, overlooks the fact that fundamental analysis can involve subjective judgments. But let’s put that down to bias-induced blindness.
Is Technical Analysis Too Popular Amongst the Masses?
One of the advantages of technical analysis is its accessibility. Anyone can set themselves up to trade using it. And they don’t even have to spend too much time learning about it.
In fact, you may not even have to buy a textbook on the subject. There are so many websites and Youtube video guides on the subject.
Information for fundamental analysis isn’t always easy for non-professionals to access. Or it’s expensive, and they often don’t have the expertise to carry out such analysis.
So, many people associate technical analysis more with amateur investors. This association may give rise to an element of snobbery amongst professionals. After all, they’ve spent years learning the concepts that surround fundamental analysis.
Too Many Tout Technical Analysis as a Fastrack to Riches
Now, there’s a wealth of helpful technical analysis resources on the internet. However, there are also many touting the latest and greatest strategy that will make you rich in an instant. Once you’ve lined their pockets.
It all plays on people’s greed for an effortless route to riches and their fear of missing out.
But this hard-sell makes technical analysis feel a bit like snake oil. It also somewhat cheapens it. Again, it makes it seem like technical analysis is for amateurs, and this detracts from its credibility as a serious discipline.
This may explain why some professionals don’t take it seriously, or at least not enough to attach more weight to it than fundamental analysis.
Does Technical Analysis Even Work?
There are so many tools available to analyze price action using technical analysis. But having a choice isn’t always a good thing.
One trap people fall into is to load up their charts with as many indicators as possible. The logic is that the more indicators, oscillators, and trend lines you have, the better. You’re more likely to get a clear picture of what will happen next.
In fact, the opposite is often true. You’ll end up with mixed signals, leaving you unclear about which you should trust.
It’s this type of thing that can lead to doubt as to whether technical analysis even works. Well, it’s easier than blaming yourself for not using it correctly in the first place.
Scientific Proof Technical Analysis Works
Most of the time, it’s better to strip technical analysis down and get back to basics because it can work. A recent study, titled – ‘Technical Trading: Is it Still Beating the Foreign Exchange Market?’, conducted in 2016 confirms this.
Researchers tested five technical analysis tools, including moving averages and support and resistance.
From the five tools, they came up with over twenty-one thousand trading rules. They tested each rule using forty-five years of data for thirty currency pairs.
Their findings showed that all the tools tested had predictive value. That was the case for all but four currency pairs. Indeed, average annualized returns came in at around 9.5% in some cases.
Of course, not all the trading rules created for each tool worked. And there were differences in performance between markets.
However, the bottom line was clear. Technical analysis can provide decent returns. That is if you use it correctly with rules and backtesting.
That’s not all. A 2019 study, titled – ‘Technical trading and cryptocurrencies’, looked at the same indicators. This time there were about fifteen thousand trading rules for the indicators tested.
The study tested the rule for trading in various cryptocurrency markets. And it confirmed the earlier study’s findings on the effectiveness of the tools.
So, professionals dismissing technical analysis as nonsense may not be wholly justified.
Why Do Professionals Shun Technical Analysis?
It’s not that professional traders shun technical analysis. It’s just that they don’t often use it as their primary decision-making tool.
Evidence from 1988 and 2001 suggests professionals in the forex markets use it. In the latter, 30% of traders said they used technical analysis.
Further, it seems fund managers also use technical analysis. A 2010 report, titled – ‘The use of technical analysis by fund managers: International evidence’, looked at a survey of almost seven hundred fund managers across five countries. It turned out most used technical analysis. However, it was for shorter-term investing that it was their primary tool.
A later study in 2015, titled – ‘Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry’, looked at technical analysis usage by hedge fund managers. The study didn’t consider individual indicators or systems used by each hedge fund. After all, most use proprietary technical indicators. It was clear that technical analysis plays a role in hedge funds’ trading in some form.
And you can hear it straight from the horse’s mouth in the following video:
So, they may not shout about it, but professionals do use technical analysis-driven systems.
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Conclusion
So, not all professionals shun technical analysis. Of course, there’ll be some professionals who dismiss it. However, the evidence shows that others consider it a valuable decision-making tool.
And they have some justification. Because despite its issues, recent studies show technical analysis has predictive value. And, it’s possible to translate that into positive returns.
So, those professionals who shun technical analysis may be missing out.
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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