Market participants do question the credibility of technical analysis, whether it works or it is just a cult that believes price can predict the market, as the financial industry is filled with fundamentalists/ financial analysts and relatively fewer technical analysts, which creates more room for the doubts. So, does technical analysis work? What is the scope & potential of technical analysis?
Does technical analysis really work?
In its purest essence, technical analysis is a study of price & an assumption that everything is accounted into the price. Still, there are underlying assumptions that one must know before using technical analysis :
Trends exist in the market
History tends to repeat itself, up to an extent
Price discounts everything
These 3 underlying assumptions are self-explanatory. All of them point in one direction which is human psychology. The market is nothing but mass human actions & transactions, all assumptions mentioned are existential because humans have emotions and they suffer from different types of cognitive biases which affect their investing and trading behavior, they tend to react in the same way most of the time whenever they encounter unexpected situations or similar situations which leads to the existence of trends and patterns. In a way, technical analysis is the way of studying the market sentiments and patterns which exist due to human’s redundant behavior and capitalizing on them.
What is the scope & potential of technical analysis?
The biggest advantage of technical analysis is that it can be applied in any market like equity, commodities, bonds, currency, cryptos, and many others, irrespective of the time frame like 1 second to multi-years
Successful trading or investing does not only involve selecting the right security but also at what time we should invest or trade that security and technical analysis is the perfect tool, which can help us in timing when to buy or sell the security.
Does technical analysis end with when to buy the security, obviously not, technical analysis is the only method that gives us a price target in advance before entering any position not only that it also predefines our risk in that position, which helps decide whether to take that position or not. As it is always said, “risk management is key to successful trading and investing”.
As the financial markets are evolving and technology is advancing, it has opened super-powerful doors for technical analysis, now technical analysts can check whether their strategy or theory works or not, and not only that they also check the credibility of their strategy and compare their performance. This backtesting process, quantitatively analyzing the data, and other statistical measures have removed the subjectiveness from technical analysis and ultimately have made it scientific.
The scope of technical analysis is increasing every day, as more and more people are trying to learn the skill of technical analysis to earn good returns
Bonus part :
We always hear big names like Warren Buffet, Benjamin Graham, George Soros, and Philip Fisher in fundamental investing and trading, as it is mainstreamed. What about the people who successfully outperformed the markets consistently using technical analysis? Here are a few super-technical analysts :
Jerry Parker : As Chesapeake Capital founder, Jerry Parker, reflects on 35 years of systematic trading, his approach remains faithful to the lessons taught by “Turtles” Bill Eckhardt and Richard Dennis. As part of Eckhardt and Dennis’s famous Turtle Trading experiment, the erstwhile accountant (and 19 other successful applicants who passed the Turtle training program) received $1 million to trade in January 1984. At the age of 25, Parker moved from Virginia to Chicago to take part and recalls most of the Turtles making 150% per year, four years in a row, with big risk, volatility, and drawdowns.
Jim Simons : James Harris Simons, or Jim Simons, is known as the "Quant King" and one of the greatest investors of all time, after having started one of the most successful quant funds in the world, Renaissance Technologies (“Rentech”). Simons founded Rentech in 1982 at just 44 years old. He served as the chair and CEO until 2010 when he retired from his role. He remains as a non-executive chair. Jim Simons ranked 23rd on Forbes' wealthiest Americans list in 2020, with an estimated $23.5 billion net worth. The Quant King also ranks first on the Forbes 2019 list of highest-earning hedge fund managers.
Richard Davoud Donchian : Richard Davoud Donchian (September 1905, in Hartford, Connecticut – April 27, 1993, in Fort Lauderdale, Florida) Wasan American commodities and futures trader, and a pioneer in the field of managed futures. The first publicly managed futures fund, Futures, Inc., was started by Donchian in 1949. He also developed the trend timing method of futures investing and introduced the mutual fund concept to the field of money management. Richard Donchian is considered to be the creator of the managed futures industry and is credited with developing a systematic approach to futures money management. His professional trading career was dedicated to advancing a more conservative approach to futures trading.
Ralph Nelson Elliott : Ralph Nelson Elliott (28 July 1871 – 15 January 1948) was an American accountant and author, whose study of stock market data led him to develop the Wave Principle, a description of the cyclical nature of trader psychology and a form of technical analysis. It identifies trends and reversals in financial markets. These cyclical patterns in price movements are known among practitioners of the method as Elliott waves.
Understanding that rule-based systematic trading is powerful, is true enlightenment & driving a rule-based strategy is a true freedom & peace in a technical trader's journey!