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The Risks Behind Technical Analysis

by Erik Grywalski
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Note:  The following article is meant to help you learn from the market and does not serve as investment advice for any specific group or individual.  For more information, please read the HSR Terms of Use.

Historicalstockresearch.com talks about some of the benefits of technical analysis, but did you know that there are also risks behind using technical analysis?

The good news is that much of the risk within technical analysis is linked to the judgement or biases of an individual or his/her firm because the market is right more often than it is wrong.

Let's be honest.

It's difficult to be 100% objective (unbiased) in the stock market, but the best market analysis sticks to current facts (what is known) and avoids predictions/forecasts on the future (what is unknown).

Frank Teixeira, CMT, CFA and Senior VP & Partner of Wellington Management Company nicely describes this point (and others) in the video below.

Frank was interviewed during the 2013 MTA (Market Technicians Association) Symposium (I did not speak with him).

Here are the risks (bold) within technical analysis that Frank outlines in the video (my comments are below):

1.  Technicals work, but the analysis of the market may be wrong (FF to 1:30)

Many poke fun at technical analysis, but looking at the market's current technical structure is a valuable way to manage risk and stay on the right side of the market.

Unfortunately, it's the individual analysis of the market that is often incorrect, not its technicals.

This may occur for at least three (3) reasons:

  • Failure to use stock charts - While this article is about technical analysis, there are many who don't use stock charts.  In its most basic form, a stock chart helps you read what the majority of investors are doing in the market.  Without a stock chart, you have no way of getting the market's opinion.  Because of this fact, I never understood the argument between technical and fundamental analysis.  Both are helpful, but technicals are essential to navigating the market.
  • Lack of attention to detail/historical perspective - Providing comprehensive and objective technical research requires the analyst to consider market history and enough current charts to get a feel for the market's tone (bullish, bearish or neutral).  Looking at a few charts per week and ignoring market history will only serve to help you miss important details about the market's health.
  • Individual/Firm Biases - Personal opinions are harmful in the stock market if they aren't backed up with objective market facts (what is known).  Many seek advice on the stock market, but if they are getting advice from a biased (bullish or bearish) source, they will be misled if their guidance is not aligned with the market.  Remember, the market represents the majority opinion and individual or group research may only be reflective of a minority opinion because of biases, etc.

"Technicals work, my failures are my misinterpretation of the technicals"

...Frank Teixeira, CMT, CFA and Senior VP & Partner of Wellington Management Company

2.  Getting too far ahead of the current data can be detrimental to reliable market analysis (FF to 4:33)

Predicting instead of reading/interpreting the market is not a sound way to use technical analysis. 

Nobody can consistently predict the market so why should you?

Yes, there will be times when you are accurate because you predicted what would happen in the stock market, but there will be many instances when you are wrong.

There are some (including myself) that anticipate what may occur based on human emotion/common behaviors of price, but predicting and sticking to an outcome when the market is saying otherwise is not very helpful in technical research.

"Recognizing the data you have and acting accordingly will make

you look like a brilliant forecaster without you making a forecast"

...Frank Teixeira, CMT, CFA and Senior VP & Partner of Wellington Management Company

3.  Unwillingness to change despite changing markets (FF to 8:35)

Having rigid rules that govern your behavior/emotions is critical in investing, but believing/insisting that the market must always do one thing can be a bad habit that clouds your market/stock outlook.

History tends to repeat itself, but you must also be open to new ideas and outcomes because market dynamics change.

"Lack of adaptability is one of the risks that we face"

...Frank Teixeira, CMT, CFA and Senior VP & Partner of Wellington Management Company

In conclusion, technical analysis is often misunderstood, but the reality is that most of the error within the discipline occurs from the "analysis" portion.  As mentioned, this is tied to an individual or group and not the market.

Luckily, much of the risk within "technical analysis" can be corrected/improved using Frank's wisdom

This occurs in conjunction with diligent practice and a refining of analytical skills using historical and current market data (what is known).

Historicalstockresearch.com provides a convenient way to review historical stock charts and practice learning the language of the market (what is known).

This ultimately helps save time, improves attention to detail and shortens the learning curve associated with the stock market.

Please click on the video below to watch Frank's interview at the 2013 MTA Symposium:

Please >>CLICK HERE<< to sharpen your charting skills using historical stock charts.

·  5 Ways to Improve Objectivity Using Technical Analysis