Ooooh boy, do I LOVE this topic! I see countless posts on Reddit/Twitter/Message Boards stating quite emphatically that TA is Bullshit and should not be used. These people are confirmed in their beliefs that technical analysis DOES NOT work and should be discarded. Although these people probably will NEVER even read this post, I beg to differ!
Technical analysis might seem like bullshit to those who have spent a few days researching the subject. I mean if you spent 1 hour trying to learn the RSI indicator and then use it on a random chart to receive buy/sell signals you have completely missed the boat. But for those that have spent years improving their craft by analysing data and re-adjusting metrics all know too well that TA is not bullshit.
Don’t get me wrong, it is not some magical formula that you can learn which will eventually tell you to buy here, sell there and cover your ass with a stop-loss here. However, it is a VERY important tool that should be a part of every crypto traders toolbox along with fundamental analysis, crypto tokenomics and risk management.
This post was inspired by a recent Reddit post I have screenshotted below. I chose to leave out the original authors alias due to the fact that this article is NOT directed at him.
I am not too sure that “every single study” has proven that it is bullshit. There have been some studies, such as the one conducted by Hoffmann and Shefrin, that suggest that traders that rely on technical analysis significantly underperform the broader market. However, this is a study from ONE specific broker in the Netherlands (with a small number of around 5000 traders) and should NOT be taken out of context to PROVE TA is bullshit.
Other studies, such as the one conducted by Smith, Wang, Wang and Zychowicz, show that TA does work - under certain market conditions. The “under certain market conditions” part is EXTREMELY important as the study showed that during times of high sentiment and high volatility, hedge funds that used TA performed incredibly strong. However, during a period of low volatility, there was no significant improvement. This distinction is important as TA teaches traders about which methods to use during trending and non-trending conditions, something which many analysts still confuse and get wrong today.
So let’s start by providing a definition of what technical analysis is and move on to explain how it should and should not be used.
What Technical Analysis ACTUALLY Is
Technical Analysis is the study of past market action to gain a gauge on where the market may head toward in the future. Technical analysis is ONLY concerned with price movements upon a chart and discounts everything to do with news, economics or the psychology/sentiment of the market. Technical Analysis should always be part of a complete trading system that involves Fundamental Analysis and Psychological Analysis.
So Is Technical Analysis Bullshit?
Technical analysis is not bullshit and it is built on the foundation of three important premises that make TA work.
Premise 1 - The Market Discounts Everything
This is perhaps the most important premise to understand. Pure market technicians believe that all the known information regarding a market is already represented within the price on the chart. They believe that as soon as some new information (or news) comes into the market, this is immediately reflected by the price on the charts. Following this, a technician believes that they will only need to study price action to gain an overall view of the market.
In theory, this is true. If news comes out that will have an effect on the price, we pretty much see the price jump instantly. However, it is still important not too close your eyes to the wider market fundamentals. Although a pure technical analyst will never consider looking up news, as a balanced trader we MUST keep everything in mind.
Premise 2 - Prices Move In Trends
This premise is easier to understand and can clearly be seen in Bitcoin during 2018 when the market established a very long term downtrend. Prices do move in observable trends and they tend to remain in the trends for long periods of time as they have a tendency to stay within the trend until ‘the bend at the end’ (trading lingo). So after a trend is established, the price is more likely to move in the direction of the trend which means that you should be entering your trends in the direction of the trend. ONLY Technical Analysis will allow you to identify the current trend in order to make an informed decision on which direction the market will head.
Looking at the news will not help you in identifying a trend. Sure, if the SEC started to regulate ALL Bitcoin companies heavily then this would certainly result in a bear trend. However, if the news is not powerful enough to reverse the current trend then the market will remain in the direction of the trend but you will still need to look at charts to see how the market reacted - hence the need for TA.
Premise 3 - History Repeats Itself
I think this is the premise that confuses those folk that believe TA is bullshit. How does history repeat itself? Just because it happened before, that does not mean it will happen again? Well, that is correct. There are no rules in this game dictating price movements. But an EXPERIENCED trader understands the market dynamics regarding psychology.
Psychology and sentiment are what drives traders to make trading decisions. The cycle of emotions through fear and greed are what help to establish trading patterns and market trends. The entire market is just a representation of the psychology of its market participants. People tend to act and react in the same ways based on the emotion of fear and greed. This action is what helps to form the trading patterns that you see technical analysts using. They are the same regardless of which market they are in and have over 100 years of data and testing to draw from.
These are the foundational pillars that have allowed technical analysts to make trading decisions for decades - and it has worked out well for many of them.
Some put forward the question “If TA actually works then why isn’t every trader already a billionaire?” - GREAT QUESTION.
As stated before, TA is not a magical formula and it can only help to make informed investment decisions. The trader themselves has to EXECUTE the trade according to their analysis which is where the difficulty comes in. Once a trader starts to make meaningful sized trades (relative to their wealth), their psychology completely changes due to the fact that there is money on the line. It is this psychology that lets a lot of traders down as they do not follow their outlined strategy. Typically, it is the trader's mental state that is more likely the case as to why they are not successful and NOT the sound foundations of technical analysis.