Technical analysis is the use of various scientific methods and tools to determine predictable patterns based on past events. In investing or trading, technical analysis (or TA), is the use of various charting platforms, tools and indicators to project future security movement based on evolving trends.
Detractors of Technical Analysis
There are many detractors of technical analysis who believe it is “junk science” or “pseudoscience.” Here is a recent article where the author evaluated whether technical analysis works. His thesis was that TA is more likely “pseudoscience” or “hogwash” than a valid approach to successful investing.
It is often believed that there are two basic camps of investors: those who believe in fundamental analysis and those who believe in technical analysis. I believe they are not mutually exclusive, and that a savvy investor or trader needs to employ both broad strategies, and a mix of tools to get the most accurate projections.
What is Pseudoscience?
The author of the aforementioned article describes TA as pseudoscience on the basis that it occurs due to the fact that many people use it, and thus it spawns a self-fulfilling prophecy. I believe 100 percent with his point that much of what happens with trading patterns is a result of this mass-market-created self-fulfilling prophecy. However, I disagree wholeheartedly with his interpretation of this reality as pseudoscience.
Here is one dictionary definition of pseudoscience: “a collection of beliefs or practices mistakenly regarded as being based on scientific method.” The scientific method is something we all learn about in elementary school. It is the step-by-step process of formulating a hypothesis, then designing and executing a test or research method to evaluate that hypothesis, and finally documenting and interpreting the research results for comparison against the hypothesis.
In the case of technical analysis, the objective is to utilize technology-leveraged research methods to research trends, patterns and indicators. The research results in a projection of a possible time and price outcome in a security that is derived from one or more of these methods. In essence, you take out the guesswork, gut instinct and intuition that hamper most retail investors and traders. Who else is using advanced technology to collect and analyze data, and to identify patterns for more accurate decision-making? Likely every Fortune 500 company and the vast majority of small, medium and large market-oriented organizations in the United States and around the world. These companies use analytics to determine the right business strategies, target markets, promotional strategies, customer-experience development and more.
The TA Hypothesis and the Human Element
In the case of TA investing, the “hypothesis” is often a trader’s belief that a security presents strong underlying fundamentals or otherwise likely offers a good long or short investment opportunity. Ideally, TA is facilitated without influence of human emotion or beliefs. In such cases, the trader relies on the pure data analysis to determine patterns as they naturally present. In fact, TA detractors believe it is the preconceived notion about a security’s direction that delegitimizes technical analysis.
What is the difference between a preconceived notion and a hypothesis? Here is one dictionary definition for hypothesis: “a supposition or proposed explanation made on the basis of limited evidence as a starting point for further investigation.” If you avoid over-thinking, this definition sounds very similar to what a person might describe as a “preconceived notion.” Thus, it seems fair to argue that scientists in any field face potential research biases from their human intuition as they carry out studies.
Real Factors that Contribute to TA Success
The factors that contribute to success in technical analysis investing aren’t that much different than those that make scientists successful in other walks of life. You need a working hypothesis to establish a premise for further investigation and to provide a basic sense of direction. You need sound scientific processes, methodology and tools that enable you to gather the most accurate and comprehensive data possible for your analysis. The TA scientist needs a thorough understanding of his or her field of experience and talent in the same way a biologist, zoologist or psychologist does. It is more likely that failed TA is a result of the abilities and accuracy of the scientist than of the science itself, or the capabilities of the tools available to conduct it.
3 Reasons That TA is Legit
There are an infinite number of reasons to validate the legitimacy of technical analysis, but here are three compelling ones to consider:
1. Successful companies employ technical analysts: Many corporations, financial services firms and other organizations employ technical analysts, and often pay them hefty salaries for their work. “Actuary” is a very well-established and well-recognized occupation in the financial services industry, particularly in the insurance sector. The U.S. Bureau of Labor Statistics describes an actuary by saying, “Actuaries use mathematics, statistics, and financial theory to analyze the financial costs of risk and uncertainty.” Sounds eerily similar to what a technical analyst does. I believe math is heavily underappreciated in the world of TA; I use it extensively as part of my methodology. Side note: Actuaries earned $102,880 per year as of the latest BLS update and job growth was projected at 20 percent from 2018-2028 (well above the national average for all jobs).
2. Invalidating TA invalidates science: Science is one of the core areas of general studies for Americans beginning in early elementary school. Ironically, it was never one of my favorite subjects. I much preferred math and numbers. I didn’t realize until later in life just how closely connected math and science were in many practical endeavors… like making money. One dictionary definition of science: “the intellectual and practical activity encompassing the systematic study of the structure and behaviour of the physical and natural world through observation and experiment.” This, again, sounds eerily similar to my investment-research methodology that I refer to as technical analysis. In fact, people within online trading communities have likely heard me use the words “systematic,” “structure,” “behavior (American version),” “observation” and “experiment” in describing TA. I likely haven’t talked much about the “physical” or “natural” world, but I definitely have talked about TA overcoming faultlines in conventional investment wisdom and connecting the worlds of fundamental and technical strategies when executed effectively. You can argue that TA is pseudoscience, hogwash or not real; the right to opinions is God-given. However, having these opinions in isolation from the opinion that “science” is one in the same is illogical. There are a lot of “data scientists” who would be out of jobs if this were, in fact, the case.
3. Self-Fulfilling Prophecies are, in fact, derived from science: I mentioned before the detractors’ argument that TA is pseudoscience or invalid because it is nothing more than investors creating what they expect to happen. First, as already noted, this statement does not accurately match the meaning of “pseudoscience.” More importantly, where did the concept of the self-fulfilling prophecy come from? Answer: science. Psychology to be exact. Here is the Britannica.com definition of self-fulfilling prophecy: “Self-fulfilling prophecy (is a) process through which an originally false expectation leads to its own confirmation. In a self-fulfilling prophecy, an individual’s expectations about another person or entity eventually result in the other person or entity acting in ways that confirm the expectations.”
Applying this definition to TA, the argument is that the only reason TA ever works is because enough people believe in it to make it work. And concurrently, suggesting that making money on TA success is not based on scientific achievement, but rather good fortune that self-fulfilling prophecies exist to turn your failed projections into profitable outcomes. If your investing or trading world centers on the primary objective of making as much money as possible as efficiently as possible, this thinking, in a word, is asinine. I’ll let you look up that definition on your own. We only know of self-fulfilling prophecies because enough scientists over time observed, hypothesized and tested the implications of this psychological human phenomenon to validate their existence. Of course, you could argue that the self-fulfilling prophecy is also a result of pseudoscience, and only exists because enough psychologists believed in its existence and sought out experimental results to support their beliefs so they could write compelling academic papers and make billions of dollars conveying its impact to the world. However, that argument sounds like an endless progression of circular thinking that is way more difficult to wrap your mind around than the possibility that TA is a real thing. Before you start in on that circle, consider this dictionary definition of circular: “(of an argument) already containing an assumption of what is to be proved, and therefore fallacious.” Sounds kind of like self-fulfilling prophecy, right?
Step back from the circle (or is it out of the circle?) and let’s focus again on making money; the goal of TA is to identify predictable patterns to improve accuracy in investing. If those predictable patterns in securities exist partly or entirely due to the self-fulfilling prophecy, that does not take away from the existence of the predictable patterns. A patterned response to a pattern is, in and of itself, still a pattern. Thus, if you can say that a projected trading outcome (say an entry or exit) is more likely than not to achieve accuracy with TA, whether the self-fulfilling prophecy is involved or not, it seems logical to rely on it as part of your strategy, and to declare it as valid as the science that led to the formulation of the self-fulfilling prophecy construct.
The Final Word and the Decision for Technical Analysis
Technical analysis is real; or it is at least real as any other form of science. You don’t have to use it, like it, trust it or care about it. However, many of the most successful and accomplished investors across all securities use it and swear by it.
Despite what others might tell you, buying into TA does not mean you cannot trust and and utilize fundamental analysis, human intuition and other forms of due diligence. In fact, I believe the greatest accuracy in investment projections comes from a combination of effectively applied research methods. Scientists in any field can attain the greatest data reliability and predictable accuracy when multiple experimental methods produce the same or similar findings. For this reason, multiple forms of investment analysis and multiple methods, tools and TA theory application are ideal if you want to ever achieve the most reliable entry and exit projections with your investing. Why leave your money decisions to chance when you don’t have to?
If you aren’t already convinced about the merits of technical analysis in your investment strategy, stay with me for a while. I am 100-percent confident that over time, I can provide you with enough anecdotal evidence of the predictive power TA offers in security patterns and trends that any reasonable observer would lose all doubt.
Whether you are a relative newcomer and want to continue this journey toward understanding technical analysis, or you have the basics down and are already a “pseudo-believer” in TA or beyond, subscribe at the “Elite” level to gain access to some of the most advanced, innovative and radical ideas in TA available to the public. You also gain access to discussions with other skilled and engaged investors and traders who want to learn and grow with each other with a “Community Membership.”