Many traders rely on technical analysis. But is it still as effective as how it used to be? Let's find out the answer below.
Every trader involved in a platform-based investment such as forex or stock trading must have heard the term of technical analysis at least once. Chartists (the term often used to identify the users of technical analysis) usually choose this analysis because it is considered the easiest way to find entry points.
This analysis is also sufficient to be used as trading provisions, as many consider that they can show predictions of price movements with 100% accuracy. Therefore, on your grand journey in the magical world of investing, sooner or later there will be a time that this single question will linger in your mind:
"If the technical analysis is so reliable, then why doesn't everybody learn about it and get rich right away? Why do I keep cutting losses and ended up losing money all the time?"
The fact is, the utilization of technical analysis on charts to generate indicators as well as trading signals is still considered insufficient to serve as a guide when traders explore the unforgiving wilderness of the forex market.
Let's take some time and debunk some myths about technical analysis, so we are clear from any confusion and able to move forward with a straight fact.
There are 7 myths about technical analysis in common:
- Only suitable for short-term trading
- Only individual traders use technical analysis
- Has a low success rate
- Quick and easy
- Assist traders in earning effortless profits
- Can be used in all markets
- Provide a very accurate prediction
If you are a fan of technical analysis, then the following myths about technical analysis are worth reading. This will help you to avoid wrong and misleading perceptions.
1. Technical Analysis Is Only Suitable for Short Term Trading
Generally, traders choose technical analysis to complement a short-term trading strategy. They consider it ideal to find out entry positions on small time frames such as the hourly or even 1-minute chart. Does it mean that technical analysis is suitable only for Scalpers and Day Traders?
Technical analysis has been existing for a very long time. Before computers were even used, ancient chartists practiced this analysis for long-term trading and investment.
For these people, technical analysis can be useful in reading the trends, so they can understand better the conditions of price movements.
Based on the explanation above, it can be said that technical analysis suits only short-term trading is not true.
On the other hand, technical analysis can be used in almost any time frame, from 1M, Daily, Weekly, to Monthly. The most important thing you need to define is the purpose of using technical analysis, whether it is for short-term or a long-term trading investment.
2. Only Individual Traders Use Technical Analysis
The other myth about technical analysis that develops among traders is that it can only be used by individual traders. Due to its simple and straightforward nature, many individual traders consider technical analysis can't be utilized by larger forex market players or institutions.
In reality, even forex players who act as hedge fund managers also use technical analysis.
Exactly because of its simple, direct, and clear nature, technical analysis is very popular and can be deployed by almost every type of forex trader, from individual traders, and multinational companies, to top hedge fund managers.
3. Technical Analysis Has A Low Success Rate
This myth has been debunked by almost all technical traders. The reason is, they owe technical analysis as guidance toward success in trading. Through this analysis, traders can predict price movements more effectively than when using other types of analysis.
For example, let's take Jack D. Schwager as an example. He is a successful trader who uses technical analysis as his main technique.
In his book entitled "Market Wizards: Interviews With Top Traders", Jack conducted interviews with several other successful technical traders, such as Ed Seykota, Bruce Kovner, and Michael Marcus.
Somehow, traders who think that technical analysis has a low success rate may perceive that this analysis is lagging (slow) like most indicators.
The fact is, there are technical indicators that are leading, such as the Stochastic or Relative Strength Index (RSI) when used in divergence analysis. Both types of technical indicators will help you during the trade because they serve to show the momentum of the ongoing trend.
4. Technical Analysis Is Quick and Easy
Most newbie traders think that arming themselves simply with technical analysis is sufficient enough to try their luck in the forex market. Apart from being easy and fast to learn, technical analysis is also considered to be able to show price conditions in the market.
Practically, they don't need to use additional "spices" if they are already equipped with technical analysis. However, the facts tell differently.
Although the use of technical analysis is easy and fast to learn, starting a trading journey with only technical analysis is not recommended. It would be better if the trading activity is further accompanied by the wisdom of risk management and sentiment outlook. Technical analysis is but a single support tool.
Another factor for a bountiful profit hunt is the attitude of the trader. Discipline and consistency are the main keys to successful trading.
5. Ready-Made Technical Analysis Software Can Help Traders Make Easy Money
You will usually encounter this kind of provocative ad while surfing a forex trading website or something similar. If you are not careful, you may be goaded to purchase and install the promoted software.
Usually, traders who are easily tempted to gain profit without doing complicated analysis are newbies.
The use of technical analysis software does not necessarily mean it will always generate results as promoted. Software providers are obliged to show their product performance, but they are not oriented toward profit-making.
It would be better if you take notes about the intricacies of price trends and decide for yourself what action to take than follow the advice of some technical software. After all, the software and its provider will not bear your losses should their signals fail miserably.
It is you who will take the brunt, so it's better to take matters into your own hands.
6. Technical Analysis Can be Used in All Markets
This technical analysis myth may hold some truths, but it is not entirely accurate. There are various characteristics and differences between one trading instrument and the other.
Forex, stocks, commodities, options, and bonds all have different market dynamics, even though their chart appears the same.
In the forex market, the candlestick patterns are formed as a visualization of price conditions in the market. It is different from non-forex assets.
For example in the futures market, candlestick patterns are influenced by volatility, and options are determined from expiration. While in commodity assets, price movements can also be determined by seasonal conditions.
What needs to be underlined is not to equate the use of technical analysis for all markets, because each market has its characteristics and attributes.
7. Technical Analysis Can Provide A Very Accurate Prediction
Until today, there has been no single master trader or expert who has stated that technical analysis can provide forecasts with 100% accuracy. Technical analysis only serves to provide an overview of price movements in a certain period of time.
For further predictions, you need to use other types of analysis.
There is one single characteristic of the forex market that probably a lot of traders find difficult to accept sometimes. That is the fact that no one can exactly guess where the price will move.
It is after all a consensus of every market participant's position. The price moves without restriction and at will. You cannot force prices to move according to your analysis, because various factors underlie these changes.
Economic data releases, conflicts between countries, or unexpected upheavals can be the reasons behind price fluctuations. Furthermore, these factors can also affect traders' sentiment towards the market, which in turn influences the price movements.
In a real-life application, technical analysis does not necessarily promise various features as seen in the myths above. Traders usually implement technical analysis as an additional tool in trading.
To be able to gain the expected profit, you need to apply risk management and various keys for successful trading. Consistency in implementing the trading plan is an important indicator to achieve accomplishment in trading.
Aside from trading analysis like technical analysis, there have been mentions of risk management as one of the most important keys in forex trading. How important is it and why a trader can't trade without it? Find out at Managing Risks in Forex Trading.