Investopedia defines Technical analysis as follows:
Technical analysis is a trading tool employed to evaluate securities and attempt to forecast their future movement by analysing statistics gathered from trading activity, such as price movement and volume. Unlike fundamental analysts who attempt to evaluate a security's intrinsic value, technical analysts focus on charts of price movement and various analytical tools to evaluate a security's strength or weakness and forecast future price changes.
I like to think of T.A. as the measure of probability of future price moves, this is under the assumption that price patterns repeat themselves over time and instruments. For instance, a defined chart pattern may occur across a number of instruments over time but only once on a specific instrument. So we could see a Triangle on two different shares at the same time but when going through each stocks history we see it only once on the initial share but two or three times on the other. This is where we need to take cognisance of the pattern itself, does it work as a probability on the one share or can we apply it across the board wherever we see it?
Every chart pattern has a history across markets and should not be defined according to just one instrument. If the pattern works 60% of the time across numerous instruments in history we can assume that it will continue to do so. The history will also give us an idea of where/when to enter a position and where we can deem the pattern to have failed and thereby trigger a stop loss. This type of thinking leads to probability trading rather than certainty. In my opinion all T.A. ideas are an exercise in probability and for this probability to be measurable it should have occurred enough times in the past for me to determine a statistical probability that I can use going forward.
I believe that this is where learning and experience differ. Experience enables someone to draw on past experienced, outcomes, to determine a probable outcome for this occurrence. Learning a pattern requires many hours of back testing, chart reading and comparisons between a definition and the charts. Well we all had to start in the learning phase and then over time we achieve experience, there is no shortcut to experience only time can give it to us.
The question you have to ask yourself is, “where am I going to spend my time?” I think the answer should be. “finding one technical definition that makes sense to me and then testing the hypothesis until I understand all its facets from entry, exit and stops to probable profits or losses.
Contributed By: Warren Peacock of The Traders Place