Why Learn Technical Analysis & Use It For Your Trading & Investing??
I’ve noticed the general rise in interest in the subject of Technical Analysis (TA) over the last few years, not just from market professionals but from the wider public. Why though should you learn it and use it for your trading and investing? In the UK I teach the professionals how to use TA as well as at Universities and have used it successfully in my own trading.
Why the increase in popularity? Maybe because of advances in technology that have brought technical analysis to the mainstream; social media where charts are thrust into our faces daily, or maybe the perception that technical analysis can hand back some control to your finances and investing in a world desiring more control.
These are just a few of the reasons for the ‘peak’ in interest in this subject along with many harder to define intangible reasons.
What I do know from my own experience, is that technical analysis is a vast subject to cover and master. There are so many tools and indicators, charts and theories in use, that to the uninitiated or even experienced it can feel like you’re leading yourself up a dark dead-end alley.
Technical analysis is a vast subject to cover and master - what should you use?
My job as a trader: to come up with trading strategies with an edge & simply to make money!
‘An Edge: the mathematical advantage you have over any game that you play over time. This advantage should result in an assured percentage return to you the player over time!’
How do I do this?
- Fundamental/ Quantitative / Gaming Theory/ Behavioural/ Technical Analysis.
- Traded algorithmically / systematically
- Executed using Technical Analysis
Trading has evolved!
Today - it is all about big data! Looking for anomalies, patterns, behaviours over large data sets. It doesn’t just have to be price (which most think TA is all about) Can be anything you can turn into a data series / set / model. E.g. economic data, company results, weather, inventories, storage, volatility etc. If you can do that then you can use TA to create highly effective trading strategies around a pov.
One of my models / trading systems is systematic / multi asset and only uses TA – and some particular types of TA from Japan – called Renko. The strategy focuses only on price movement (not time) – through statistics created around TA it finds the optimal instrument to trade, trade sizing, portfolio management (creating optimal portfolio), when to get in / out of the trade etc. Its goal is to capture price trends and reversals. Results: 300% return over 1 year (6 Sharpe Ratio)!
TA is a massive part of the whole process. It is excellent for:
- Trade Timing – entry / exit
- Risk & Trade Management - making and saving you money!
- Capturing repeatable patterns /trends
- Capturing price action in different time horizons
- Strategy design / back testing
- Performance measurement and analysis
- Portfolio management
- Saving you time
- Creating discipline and consistency - helps your trading 'psychology'
- Automation
TA is thought of as just a tool for analysts to call where the price of a market is heading next. It is so much more than that! My goal of using TA is to make my trading as objective (rather than subjective) as possible. TA is certainly something you should consider adding in to your trading and investing toolbox!
Why Does TA Not Work?
TA comes in for a lot of criticism and negativity:
- It’s a great hindsight tool,
- Simply just self-fulfilling,
- Great for selling courses,
- It’s a dark art,
- Never works when I follow the rules,
- TA’s are just glorified ‘weather forecasters’!
Users don’t appreciate that it’s a subjective and objective analytical tool rolled into one. Users don’t understand how to properly apply it and because its so easy to use, misuse it. It’s seen as the ‘golden ticket’ / ‘holy grail’ – it’s not! You can’t simply just ‘follow the book’ and expect it to work – if life was that simple I’d be a brain surgeon, professional golfer, artist, pilot all at the same time!!!
REMEMBER TA IS A SCIENCE WITH A LOT OF SUBJECTIVITY THROWN IN!
Everyone is allowed their own opinion. I’ve worked with some of the best fundamental traders, some of the best ‘quants’ some of the best ‘technical’ traders out there and what I’ve come to learn is that it is ‘horses for courses’.
How To Think About TA?
Technical analysis is a very straightforward concept: ‘It is the analysis of market activity (price, volume and open interest), predominantly through the use of charts, with the goal of forecasting future price trends.’
Many of the tools used in technical analysis can also be found in use in areas such as quantitative analysis and behavioural science. It is a very flexible, adaptable, multi-time dimension frame approach to trading and investing.
It’s built on 3 fundamental pillars:
- Market action discounts everything.
- Prices move in trends
- History repeats itself.
Technical analysis is very different to Fundamental Analysis (FA). FA is all about value; is something fair value, under value or over value?
Decisions to trade or invest are based around a lot more physical research - earnings, dividends, assets, new products, interest rates, a country's economic make up, how much copper is coming out of a mine or oil being pumped out of the ground etc etc.
The downside to FA is that it can take a lot of time to put together and is difficult to execute, especially around trade and risk management concepts. It does work though and cannot be argued to be any worse or better than technical analysis.
Mathematicians often disagree with the approach and methods of both TA and FA due to the efficient market hypothesis / random walk theory. They often say these approaches are self-fulfilling. But both do work - some of the richest, most successful traders ever have adopted these approaches! The end game is to make money and if you find an approach that works then you should stick to it. Often it comes down to your own personal psychological make up as to which approach, you'll adopt.
I see TA as telling a story that needs translating – the fundamental, behavioural, sentiment, quantitative analysis is already built into the price.
TA is giving us the tools to translate what has gone on and give us a better chance of what is likely to happen….….and on top of that it is giving us a unique set of tools separate to the other forms of analysis to help us create that elusive edge!
Some Examples:
It can help you measure the Behavioural Psychology of financial markets and plays an important part in driving cycles and trends:
It can give you the right tools at the right time to trade!
Oscillators are a good example. They can help you see the momentum of the market and whether a market is overbought or oversold:
Example: OVER BOUGHT & OVER SOLD Intraday Pivots + Stochastic : FTSE 100 30 min chart
Price patterns can help you translate the price action better (TIP: more useful if put in conjunction with other indicators):
Some typical price patterns:
Basic Example USDJPY Candlestick chart (Charts: TradingView):
'Gaps' price pattern example in stocks:
Gap example: Leonardo (LDO) (Charts: TradingView):
TA can also come in the form of different chart types, which can certainly give you a different angle / edge on your trading:
A Kagi Chart vs a standard Candlestick chart:
The Kagi Chart – No time only price : Kagi S&P 500 chart versus the traditional candlestick chart S&P 500 chart. (Charts: TradingView)
It can also help you in your Trade & Risk Management:
Successful trading is about helping yourself and putting the 'odds' on your side. Often forgotten and overlooked is the use of technical analysis for Risk & Trade Management. It is a very strong tool to help you in the world of risk. It gives you a set of rules, i.e., fixed and objective parameters around which to trade, which in turn, creates the psychological discipline you need in your trading. Many people go into trading blind - no rules, plans, strategy and especially no risk & trade management concepts to deploy. That's why so many lose at trading.
You can use support and resistance to control the risks within your portfolio or trades. For example; you can set stop levels to manage individual trade risk i.e. price levels where if your trade idea goes wrong you get out, or potential profit taking zones where you’d exit your trade in the money. You can even estimate whether a trade is worth taking or not!
Real-world example: Gold (Charts: Trading View)
And for me its all about turning TA into a strategy. How do I do this?
- Idea
- Back test – all price / TA data – inputs to strategy
- Quantitative / Statistical results
- If = Edge = Trade
- Edge can be measured e.g. Sharpe Ratio, Kelly’s Criterion
- Use TA results…..Kelly % = W-(1-W)/R
(R = av. W/L ratio and W = historical win %)
E.g. 60%/40% Win / Loss ratio, average risk return = 1.5% gain / 1% loss
Plugged into formula: 0.6-[(1-0.6)/(0.15/0.1)]= +33.3%
So you could use 33.3% of capital on a particular strategy.
5. Build into portfolio / risk management
Final Thoughts:
Hopefully that has given you some idea how to apply TA into your trading and investing and consider adding TA to your trading toolbox! If you want to get started on Technical Analysis I have a great FREE video on my YouTube channel that will give you all you need to know to get you off and running: Link to the video that you can copy and paste into your browser: https://youtu.be/_2cZz80znFg
If you’d like to find out more you can get in touch with me via:
- Email: info@thestophunter.co.uk
- Website: www.thestophunter.co.uk
- YouTube: thestophunter
Best of luck with the trading,
Regards
Stephen
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