The poor reputation of technical analysis is well deserved. It’s their own fault really. The way this field has expanded makes it very difficult to take it seriously. It’s been reduced to a slogan used by scam artists to sell nonsense books, trading systems, newsletters and ‘mentoring’ based on quasi religious numerology and mysticism. Professionals stay clear of the term technical analysis for good reason.
What is technical analysis?
Well, that’s just the problem, isn’t it. There is no definition. Anyone can make up anything and call it technical analysis. The field now seem to encompass everything from drawing trend lines to astrology.
Technical analysis started out with quite simple concepts, which are not all that dumb. In the early days, it was about looking for directional trends in prices and divergences between related market indexes. Experience told traders that when prices start moving in one direction, they are more likely to continue than to reverse. Technical analysis was just a way to visualize this concept.
Divergences was mostly about comparing the Dow Jones Industrial with the Dow Jones Transport, the two most important indexes at the time, and draw conclusions from potential differences.
Adding things like simple oversold/overbought indicators is still in the realm of sanity. Again, experience had taught traders that extreme short term moves are often followed by a sudden pullback. Emotions run wild as the price takes off, propelling the price further until a short term correction sets in when the buyers are already in and there’s no one left to push the price higher. Common sense things where technical analysis was used as a tool to visualize abstract phenomena.
Then the problems set it. The visual nature of technical analysis lends itself to get-rich-quick stories. After all, there’s no need for all that hard work, right? Why waste time learning tough things and gaining real life experience when all you have to do is look at a chart and draw some lines? It was only a matter of time before this field was completely taken over by snake oil salesmen. To be fair, some of them are probably just delusional and not outright immoral.
There are no rules for what technical analysis is. So it became everything. In particular, everything that is easily sold. The more colorful naming and background story, the easier the sell.
At first we had the indicator explosion. An easy way to get famous in the field is to create an indicator. Especially if you manage to get that indicator included in standard technical analysis software packages. So everyone and his grandmother started making indicators in hopes of fame. It’s a comfortable illusion, that all you need is to find the right indicators and you’ll be rich in no time at all. Just get those parameters right.
Then we have the field of exotic names. Doji, three little soldiers, spinning dragons, crouching tigers, ichimoko, harami, spanking monkeys, and tons of more colorful names. Well, I might have made some of them up, but if others are allowed to make up random exotic names, why can’t I? Beware of anything that sounds ‘cool’. Most likely it has no other use than to sell products that won’t help you.
Down the rabbit hole we go
The next step is the outright lunacy. The world of utter fantasy. You might want to drop some acid before going down this route to help the suspension of belief. You see, there are these magical numbers that govern the fate of the universe, which control everything in the world, from the formation of galaxies to the horns of goats to the behavior pattern of humans and by dividing these magical numbers found by a genius Italian rabbit counting mathematician named Leonardo a few hundred years ago you get equally magical ratios which you can use to predict stock price moves to the exact decimal and make tons of money, if you just buy the right books and courses first.
Fibonacci numbers are for the mathematically challenged. Sure, you can go ahead and flame me now. I’ll wait.
With a little creativity you can fit anything you want to a Fibonacci retracement, projection etc. The apparent precision that the decimals imply is just another layer of the illusion. Instead of saying that sometimes prices move back by around a third, this silly back story would have you believe that the prices should move exactly 38.1966%. I wonder if you’re supposed to use this on price series or total return series? How exactly should you adjust futures prices for term structure to be able to take advantage of this precision? Does it work both on spot and on future, and given the term structure, is that even possible? These questions are never answered, since these numerology approaches are used by people who don’t understand the real life problems it implies.
Speaking of colorful back stories, how about a magical set of wave patterns which also govern everything in the universe? You see, everything in the universe moves up in a formation of five waves and them move down in a formation of three waves. If you can look at a chart and figure out which wave we are in you can use the magical numbers described above to predict exactly where the prices will turn. And when you turn out to be incorrect, you can always revert to your secondary wave count. Or tertiary. The leader of the Wave Cult has been predicting the end of the world for decades and whenever the markets are falling, he’s interviewed on TV about his accurate predictions. Kinda like hailing the genius of a stopped watch for being correct twice a day.
From here it just goes down hill. Lunar cycles, planetary alignments and outright voodoo. Hell, if someone’s willing to buy it, someone else is willing to sell it. And it’s all embraced under the umbrella of technical analysis.
Technical analysis as a shortcut to riches
The seeming simplicity of just using a chart with some indicators or lines attracts many beginners. It would seem like such a great shortcut. You don’t really need to do real work, just look at a chart. Throw in a few indicators named after some authors and you’re done. It’s a seductive idea, that you don’t really need to work hard. This is why the field is attractive to retail traders and that in turn is why it’s an attractive field for those peddling products based on colorful names and back stories. You don’t even have to leave your home, just spend an hour over the weekend and beat all those silly so called professionals. Of course the pitch is going to sound appealing to newcomers.
Why is technical analysis not taken seriously?
Because the supposedly serious practitioners in the field never tried to deal with the the fringe lunatics and scam artists. Quite the opposite. The major technical analysis organizations are embracing this kind of crap and even including it in the curriculum for their courses. Of course, they are in the same boat as the people making this stuff up. The technical analysis organizations make money on membership fees. To grow membership, they need a broad base. To reach this goal, the best business plan would be to allow people to believe that there are magical numbers governing the universe and that you can get rich quick if you just learn to master this mysticism. Every member counts, even if they are impressionable marks who believe in numerology.
It’s their own fault
It’s the fault of the technical analysis industry and organizations that the field has been reduced to a mine field of scam artists and lunatics. Critical thinking is not encouraged. Simply have faith. The field has effectively turned into a religion. It’s become a joke.
There is a common understanding that you’re supposed to treat technical analysis like a science. Most books on the topic are written in such style and the courses by the major organizations approach the subject in that manner. Still they include pseudo science, numerology and outright nonsense without question or critique.
Once technical analysis was something generally accepted in the financial community. Now it’s reduced to a tag line for a collection of scams targeted at retail traders. It’s really a shame. There’s a core of useful ideas in basic technical analysis, but it’s buried under such a thick layer of bullshit that it’s not even visible anymore.
Are you saying that all technical analysts are scam artists?
No, I wouldn’t go that far. There are actually plenty of professionals using concepts originating from technical analysis. Usually they don’t use the term though, for reasons made clear above. It has a very poor reputation. Trend following, the main strategy of the 300 billion dollar CTA industry, has its roots in technical analysis. A large part of quantitative, systematic trading is based on ideas from that came out of that field.
There are even many people with the job title of technical analyst who are serious, competent and responsible professionals. They are getting fewer and fewer, but they’re out there. These are the people who need to take a stand against the scope drift of their field.
As I said, I and many others in the hedge fund business use ideas and concepts from technical analysis. We look at charts, we use the occasional indicator, draw conclusions from price patterns and run simulations to test quantitative time series theories. We work in a pragmatic manner, using what works. But we don’t deal in magical numbers, holy wave counts or the thousands of oddly named patterns and concepts which keep increasing every day to sell new junk.
Critical thinking. Question everything. Except of course if I say it. Then it’s the truth.