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Those of you who’ve been reading me a long time, know how skeptical I am of technical analysis. Trading technicals in a void is like making medical decisions solely on the thermometer reading. At their core technicals are simply signals for sentiment or momentum. That’s all.
Given the funda context sometimes technicals can be an excellent forecasting signal and sometimes they can be a horrible one. One thing is for sure. With very few exceptions (such as major price milestones) technicals almost never drive price action -- they simply reflect it.
Pure technicians always get angry at me when I say that, but the proof is in their own actions. How many technicians will stand down ahead of a fundamental release of data? If price action was everything then you can you just ignore funda at will. Go ahead take that long ahead of NFPs. We all know how well that works.
You can, of course, trade off long-term charts and ignore the day to day noise but even there you are still subject to funda drivers. Tell me -- how did those weekly charts do on the Brexit vote? (Hint -- they walked you straight into a trap).
Anyway, my point isn’t to prosecute the case of what drives price action -- that argument has been settled a long time ago. Rather, I’d like to ask a simple question -- what are technicals good for?
Some die-hard fundamentalists will say -- absolutely nothing. Technical indicators, after all, are simply derivatives of price and therefore lagging by definition. But, as they say in the software business that’s a feature, not a bug.
Why would derivatives of price be useful to traders? Precisely because they can provide a visual narrative that can be difficult to see any other way. Indicators smooth out the randomness of prices and allow the trader to separate the signal from the noise. Take something very simple such as short-term moving average crossing a long-term moving average. Every major price regime change in the market starts with that dynamic. Now granted many of the moves fail to produce a sustainable trend, but by quantifying, standardizing and classifying each successful move you can sometimes tease out a meaningful edge and ride the wave to profit.
Technicals can also act as a check on your ego. If you are absolutely convinced that price should move one way, but technicals are actually showing the opposite chances are that you are wrong. One of my favorite setups is to have news print one way, but price action react the opposite. In that situation, technicals are almost always right.
Ever since our days on the savannah, we have been pattern seeking animals. It’s what kept us alive to the present day. Technicals are simply a unique manifestation of the same dynamic in a different environment. Instead of lion behavior, we watch price behavior and while that information is as incomplete to us as the herd movements were to hunter-gatherers, it is nevertheless valuable. It helps to inform our experience. It provides distinct knowledge which we can then try to turn into trading wisdom.
So even if you are diehard funda trader, you need to look at the charts. They tell a narrative that could be the key to your next profit in the market.