Does Technical Analysis Work?
One can find many books and articles on technical analysis written by well known authors. But does everything written in these books can be used on modern financial markets and does the given information sufficient to trade successfully?
If you open any book on Technical Analysis you will find many technical indicators explained there and trading signals the indicators can generate. Along with the signals explanation you will see many charts and examples of profitable trades on them. This can give reader an illusion that he now knows a secret of how to trade. The reader sees one successful trade example, another one and he starts to believe he knows almost everything on how to trade profitable. But actually in real life this only means the beginning of a long way to the successful trading.
If you try to examine technical indicators on some longer period of time you will discover that they do not work so perfectly and generate many false trading signals that lead to unprofitable trades. And this is really so, a technical indicator or a mix of indicators in conjunction do not usually work ‚¬"as-is‚¬ and can not usually drive you to profitable trades. Does that mean that technical analysis is absolutely worthless? Fortunately this is not true. One must consider technical analysis as a basis for understanding of financial markets. It is just like education, it can not bring you the money, but you can not find a good job without good education.
If technical analysis is only a basis then what is the next the future trader should be focused on? The next target is a trading strategy development. A set of rules that gives you not only a signal to open a position but also steps on how to maintain currently opened positions. It is also money management as it is very important to understand the size of your positions compared to total investment capital.
A trading strategy this is what you should want as a result of your work. This must be unique strategy. Rules must be precise and concise. And what is most important, it has to be tested on historical periods. This process is called ‚¬"backtesting‚¬. Only having positive backtest result you can go live trading. One important point I would like to mention about backtesting, many traders perform backtesting many times in order to obtain better results. But this can cause ‚¬"over optimization‚¬ effect. In order to avoid strategy over optimization you should also run the test on out-of-sample period which was not used in initial optimization process. In-sample period is that you optimize your trading strategy on and out-of-sample period is for final check of that the optimization results are valid.
If you open any book on Technical Analysis you will find many technical indicators explained there and trading signals the indicators can generate. Along with the signals explanation you will see many charts and examples of profitable trades on them. This can give reader an illusion that he now knows a secret of how to trade. The reader sees one successful trade example, another one and he starts to believe he knows almost everything on how to trade profitable. But actually in real life this only means the beginning of a long way to the successful trading.
If you try to examine technical indicators on some longer period of time you will discover that they do not work so perfectly and generate many false trading signals that lead to unprofitable trades. And this is really so, a technical indicator or a mix of indicators in conjunction do not usually work ‚¬"as-is‚¬ and can not usually drive you to profitable trades. Does that mean that technical analysis is absolutely worthless? Fortunately this is not true. One must consider technical analysis as a basis for understanding of financial markets. It is just like education, it can not bring you the money, but you can not find a good job without good education.
If technical analysis is only a basis then what is the next the future trader should be focused on? The next target is a trading strategy development. A set of rules that gives you not only a signal to open a position but also steps on how to maintain currently opened positions. It is also money management as it is very important to understand the size of your positions compared to total investment capital.
A trading strategy this is what you should want as a result of your work. This must be unique strategy. Rules must be precise and concise. And what is most important, it has to be tested on historical periods. This process is called ‚¬"backtesting‚¬. Only having positive backtest result you can go live trading. One important point I would like to mention about backtesting, many traders perform backtesting many times in order to obtain better results. But this can cause ‚¬"over optimization‚¬ effect. In order to avoid strategy over optimization you should also run the test on out-of-sample period which was not used in initial optimization process. In-sample period is that you optimize your trading strategy on and out-of-sample period is for final check of that the optimization results are valid.
Source...