Is technical analysis rubbish?

My first proper job in financial markets was as a currency technical analyst, and I passed the Society of Technical Analysts exam some time back in the mists of time – so this may seem something of an odd topic to write on.

However, I do think so many of us make things much more complicated than they have to be when it comes to markets, and a lot of this problem lies with the evolution of technical analysis in recent years.

Back in the good old days when all we had was a simple bit of graph paper with a price chart on it, lots of emphasis was placed on straightforward analysis such as the idea of support, resistance and trends.  Since then we have all gained access to a myriad of technical indicators, and with just a few clicks we can produce very important-looking charts such as this one for the FTSE 100.

FTSE 100 chart

 

For the uninitiated in the world of chart gobbledygook, this is a daily FTSE candle with an RSI, MACD rainbow, 200-day moving average, SuperTrend, Fibonacci retracements and Bollinger Bands. And very pretty it is too.

It is far too tempting to throw lots of things on a chart, thinking it adds more – but I know I am not alone in thinking that charts like this mean you end up not seeing the wood for the trees. I think there is a temptation among all of us when we start getting involved with financial markets to believe there is a magic system out there – if we can just get our settings on our second derivative smoothed stochastic correct, then every trade will be a winner. Of course this is rubbish, but I think it is a path that many of us are led down in the beginning which ends up being both a waste of time and frustrating.

When all is said and done a market can only do one of three things: go up, go down, go sideways. If a market such as the Dow, for example, has been going up for a year, six months, three weeks, two days, it is unlikely to stage a major reversal just because the MACD says it should. Shockingly, the Dow Jones index probably doesn’t even know the MACD exists.

I think we can all do ourselves a favour by keeping things simple. I am a big fan of trading with the trend and looking at how the market reacts around previous support and resistance levels – important prior highs and lows. Of course nothing works all of the time, but here are a couple of recent examples from popular markets, highlighting the principle.

It is easy to see just how important the 1,2750/1.2800 area has been for EUR/USD in recent months – the market clearly likes the euro down here.

 

EUR/USD chart

 

And for a shorter-term example from recent days, just look at the support for the Dow ahead of 15,400. The market clearly thinks drops back towards here are buying opportunities, so who am I to argue?

 

Wall Street chart

 

These levels do not stay intact for ever, of course, otherwise markets would just remain stuck in sideways ranges. But they can offer up sensible low-risk, potentially high-reward opportunities to get into a position, and give a clear indication when you are wrong.

To reiterate: nothing works 100% all of the time; there is no Holy Grail. Ultimately it is all about finding a strategy that works for you and you feel comfortable with. For me, it is appreciating that it does not have to be a complicated one that leaves your charts looking like an impressionist painting. As with many things in life, sometimes the simple approach is the best one.

 

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