Why you can’t rely on technicals

I’ve always viewed myself as a technical trader. I like my technical analysis … drawing lines on my charts … watching my candlesticks …

So, what’s happened?

Have I had some kind of epiphany?

Have I lost my faith?

Am I abandoning technical analysis?

This week, I read that seven seismologists in Italy were being charged with manslaughter over the tragic earthquake that killed over 300 people back in April 2009.

I was reminded about how badly human beings need someone or something to blame when things go wrong.

Back in 1987, the nation’s favourite weatherman, Michael Fish, became a hate figure when he failed to warn us about the impending hurricane.

I don’t know anything about seismology or meteorology, nor do I know whether these scientists could have done more to protect us from the destruction and loss of life that these disasters caused. But I do know that science is getting a hard time here.

It’s nice to have straight answer – will it rain tomorrow? Yes or no? Will disaster strike tomorrow? Yes or no?

Surely that’s what these experts are for?

Right?

As ever, the answer – and the world in general – is more complex and wooly than that.

And I’m afraid that our obsession with “straight answers” is putting our scientists in a very sticky situation.

The trading community wants clear facts

The “science” of technical analysis has to deal with similar issues.

Traders want to know what trades to place … and what results they will get …. And they look to the so-called trading experts to help them with this.

The questions I hear again and again are …

“Which is the best trading strategy?” …

“Which is the best time frame to trade?” …

“Will the euro go up or down?” …

“Should I sell now?” …

And many traders believe that if only they knew enough about technical analysis, and looked at enough charts – they could find the answers to all these questions.

The problem is that we’re asking the wrong questions here. It’s a bit like trying to learn golf by asking Tiger Woods: Which is the best iron to use? or How hard should I hit the ball?

I’ve been guilty of this mistake myself.

“Does this head and shoulders pattern mean that the price will go down? … I’ll add an RSI indicator … now include some moving averages …”

Surely, with all this gumpf on my chart, my trading signal can’t be wrong?

Oh yes it can!

Technical analysis cannot tell us what’s going to happen in the future – it can direct us and guide us towards possible outcomes, but if you expect definite outcomes, you’re going to be disappointed.

Trading is not an exact science – there are too many variables within the markets and within the millions of people who trade those markets to accurately predict what will happen.

Just as there are too many variables in weather systems and seismic activity.

So, in the light of this – am I going to abandon technical trading?

I wouldn’t be the first trader to do it.

The trading world is littered with technicians who’ve lost their faith in analysis, as signals keep letting them down.

What I have done is I’ve taken a decisive step back from technical analysis.

I’ve tried to remove a lot of the indicators from my charts – and to look at what the price is doing. There are a lot of patterns that you can notice without the help of moving averages or parabolic SARs – in fact, you probably wouldn’t notice them if your charts are clogged up with this technical stuff.

Technical analysis can involve a great deal of work – and will still get it wrong a fair amount of the time.

However, I still have the blood of a technical trader flowing through my veins – and I do still believe in the value of these patterns and signals.

Yet, in the past few months, I feel that I’ve developed a better perspective on what I can get from my technical trading signals – and what’s simply asking the wrong questions of those signals.

Just because the weatherman gets it wrong some of the time (even a lot of the time) doesn’t mean that he’s not worth listening to. As long as we accept the fallibility of his statements – they are based on probabilities, not on clear cause and effect.

Technical analysis has its place – but make sure that it knows its place and guides your trading strategies rather than dictates them.

How you can free yourself from some technical analysis too …

Now, I’ve been dropping hints like a trail of breadcrumbs about the new strategy that I’ve been using in recent months – the one that follows the Dow Jones, has a phenomenal success rate – and has released me (to some extent) from the shackles of technical trading!

If you’re wondering when I’m going to get around to telling you about it in full – I promise that it’s coming soon. There’s been a slight delay at the publishers, but it’ll be within the next couple of weeks, I guarantee.

Related posts:

Lies, lies and the markets What the science says about market direction