Hi @nithin,
I’ve been thinking about the best strategies to deploy while trading and have often circled back to technical analysis. Why does technical analysis work? is it more like a self-fulfilling prophecy / repeating patterns?
3 Likes
Hmm… this debate has been on for many many years now. I think you will find enough content online which is for & against technical analysis.
Firstly there is nothing in the stock markets that just “works”. 
If there was any guaranteed way to profit, it will be traded on until there isn’t any. So when you look at charts, and see some indicators or drawings and if it seems like, “Damn, this works”, it is because of hindsight & selection bias.
It is when you feel after an event is over that you could have accurately predicted that it happened. This feeling gets accentuated when you selectively look at only certain events.
So, I don’t think there is any entry or exit strategy that “works” when trading the markets, technical analysis, or otherwise. It is all about trading higher probabilities of something working and an unemotional risk management system. This is where technical analysis works well, especially for retail traders.
Most TA strategies are trend-following.
This means if something is going up you buy and if something is going down you sell. Instinctively most of us try to do the opposite, one of the biggest reasons for retail traders to lose money. In TA by mostly trading with the trend of the stock, you increase the probability of winning when trading - slightly. But here is the thing, that slight difference matters.
I suggest you to watch this brilliant talk by Stephen Duneier at Ted Talks. He shares how Djokovic went from being #600 in the world to #1 just by increasing his success rate from 49% to 53%.
By the way, trend following is also what we have to do in all walks of life to increase the odds of succeeding. Be around people who are doing well, work in companies doing well, take courses and upskill based on what is most in demand, etc. But that doesn’t mean to say that outliers or people who go against the trend don’t succeed. Just that the probability of success reduces. Btw, passionate outliers who get lucky also tend to be called disruptors and usually have massive outsized returns, that is provided they get lucky. But luck or hope, unfortunately, isn’t a strategy that you can rely on when trading or in life. Hence trend following is usually a safer and better option for most people as most don’t understand the concept of risk to reward and also because you shouldn’t be taking higher risks before spending at least a few thousand hours trading/learning the markets.
Risk management
When trading using TA, there is usually a defined stoploss or a point where you exit if things went wrong. Not exiting a losing stock is also what hurts retail traders the most (loss aversion bias). The best bit of Technical analysis is that there is a defined stop-loss on every trade, and helps in the most important aspect of trading - Risk management.
Btw, on a related note, here is a discussion I had with Jack Schwager a few years back. You can check the full video here. If you haven’t read Market Wizards from Jack, make sure to go read them, they are amongst the best for anyone trading the markets.
Nithin: I’ve heard about your transition from being a fundamental trader to becoming a discretionary technical trader because of all the risk management benefits you got from following technical analysis. Can you talk a bit about this?
Jack Schwager: It’s kind of interesting. I am not pushing anything but I’ve interviewed traders who made millions or hundreds of millions on fundamentals so I am not knocking fundamentals and it’s right for certain kind of people. I’ve seen both kinds, traders who have done tremendously well with fundamentals and traders who done phenomenally well with technical.
But for myself, the problem I always had with fundamentals is that inherently in the approach, the more wrong you are the more sense it makes to add to the position. So, if I think that some market is underpriced let’s say at $6 and I go long because my fundamentals tell me that this is cheap. If this goes to $5.50 and nothing has changed then it logically means that it is an even better deal and that I should buy more and to certainly not get out.
Not only does fundamentals not have any intrinsic risk management, by its very nature anti risk management. Because if you are trying to assign a value to an item and if it is going against with any change and I emphasize without any change in the facts as a fundamental trader your logical step would be to add to a losing position.
This from a risk management perspective isn’t very good. Whereas in technical if you are going with the trend or even against a trend I can say that I can expect the market to fail in this zone and if it goes beyond the zone by a 100 points then my call is wrong and i am out. Even if you are going with or against the trend you can apply risk management because technical analysis establishes an area where you want to either buy or sell.
Any reasonable approach you have should allow for asking the question “Where am i wrong?” and that allows for placing a risk management stop. Whereas in fundamentals the market going against you is not a sign that you are wrong but rather a sign that you should put on more.
So, that’s the crux of why I completely transitioned away from fundamentals but again I’ve interviewed many people who think that technical analysis is a bunch of malarkey and have done tremendously well on fundamentals. So it’s really about what’s right for you.
And finally, to use technical analysis in today’s world there aren’t any large entry barriers. It is easy to learn and get started. Almost every trading platform gives you access to good quality charting. And today you have platforms/APIs where you can backtest strategies so that you are not affected by the sample selection bias. By the way, if you don’t know to program, you can check out Streak (one of the startups we have partnered through our incubator/fintech fund Rainmatter).
Hopefully, this helps.
32 Likes
Technical analysis has helped me a lot in trading. The pivot point has helped me a lot in trading especially in intraday trading to know the support and resistance. It has helped me to put the stop loss below the support and target near the resistance. The pivot point has helped me to keep minimum risk reward ratio 1:2. Candlesticks has helped me to know whether stock will be trending or will reverse. The volatility indicators such as bolinger bands and ATR has helped me to know the volatility of the stock. Bolinger Bands has helped me in a sideway market and ATR has helped me where to put the stop loss. So Technical analysis has helped me a lot.
3 Likes
TA is matter of belief , very similar to something like religion.
TA is not based on math. Infact math clearly says that stock prices follow Brownian motion or stochastic process and is proven by mathematicians.
So if you believe it works , it works for you.
5 Likes
Technical analysis can provide very accurate price predictions. Technical analysis is also about probability and likelihoods, not guarantees. If something works more often than not, even though it doesn’t work all the time, it can still be very effective at generating profits.
1 Like
It is the hope that kills 
when things started going south investors, traders averaging Yes Bank in hope of things will get better is prime example.
1 Like
thats not 100% true 
… stochastic calculus allowed us to mimic stock price process when we had very little data… now ofcourse we know return processes are not gaussian or pure brownian motion as you say
Some use fundamental analysis some use technical analysis to understand the behavior of the masses towards the stock prices but both haa uncertainties.
1 Like
Stock market is game of uncertainties… be it technical or fundamental analysis these only help us make calculated decisions rather than entering at random times or in random stocks but nothing works 100%, you will either make profit or make a loss there is 50 - 50 chance of both, no middle ground. In long run what serves us best in stock market more than any strategy is proper risk management method, if we have a good risk management system in place and have proper discipline then even if we win only 50% maybe even less, maybe even 40% of the time, we can still be profitable.
2 Likes
True all are just chances, now i say nifty will fall 200 points on 2 nd December so have to wait and watch.
any mathematical proof of this?
You can recall an idiom “Where there is will, there is a way”. So, a little modification to it “Where there is money, there is trend”. As we know TA depends upon the concept of History repeats itself but not exactly though. This all depends upon human psychology as this is linked to our emotions. So if you are a person who is very active during the trading hours TA will definitely help you.
1 Like
This debate has been going on for many years now. I would say try your hands in TA. Learn it, as there is never any harm in learning something. When you are comfortable with it, you yourself would be able to answer whether it works or not. Do not go about reading other people’s experience as that can be misleading. Be your own judge and find out yourself!
1 Like
Look at the return distribution… its not going to be like a Gaussian distribution ie : symmetrical with only 1 mode but more importantly tail distribution being close to zero prob at far end, but then Gaussian functions are mathematically beautiful as trackable…
Mostly we are going to be better off with T-distribution, even though not good with symmetry assumption but not tails are not that trivial… Problem is we can’t model it well and hence stochastic calculus would fail…
But stochastic was for a world pre 2000, eventhough Blacks has made the world to think broadly in its way…
I don’t know about Brownian motion, but when it comes to normal distribution, say most of the time the market returns follows a normal distribution but what happens during a black swan, that’s a negative skew or +5ve sd.
According to gaussian theory we should have a black swan only in 340 years but in reality the us stocks markets faced 5 black swan events in 15 years
2 Likes
@nithin tweeted yesterday, questioning: Does technical analysis work?
This may be one of the more usual searches, and many beginners may still be asking this question within, thus opening an old thread.
One of the first lessons I learned about technical analysis was that the “Trend is your friend.” The importance of this saying is to always follow the trend and never go against it, while always keeping a stop loss in mind.
My trainer said you’ll probably be profitable if you do this. 
Here’s a live mint post on how TA has evolved over the last century.
Interestingly, the number of people actively following technical analysis has been declining in recent years.
Furthermore, the tweet pointed out the shift in trading behavior among active traders.
Today there are maybe not more than 15 lakh daily active traders in India. A small number in the India context but they contribute over 80% of the exchange volumes. The trend among traders today seems to be to trade news and sentiment using options strategies.
If you haven’t read this yet, here’s Z connect post discussing the basic rules of trading, emphasizing the significance of combining fundamental analyses with technicals. It gives useful insights on laying a solid basis for effective trading.
What are your thoughts? Do the TA indicators and patterns still help in deciding the best entry and exit points? Do you follow any analysis that have been really helpful?
It’s all Human Bias. Whether it is Technical Analysis or Fundamental Analysis, it will only help to confirm the bias. Then intuition comes into play.
The job of a trader is managing the risk, reward depends on how well he managed the risk without having any recency biases in his head. 
1 Like
whether or not technical analysis works is a question that each individual investor must answer for themselves. There is no right or wrong answer, and the best way to find out if it works for you is to experiment with it and see how it goes.
Totally agree. 
1 Like