I saw a nice, concise
post by Greg Harmon of Dragonfly Capital this weekend on the topic of "What is Technical Analysis" and I thought I'd bring it over, both to educate readers who might not be familiar with the framework and to have it somewhere I can refer to it in the future! He does a great job if explaining not only what it is at the 40,000 point foot of view but what it is not – and I often take for granted the fact that many people who stop by the website have never heard of the concept or only vaguely know why anyone would or would not use it.
In many ways I think of technical analysis ("TA") as hocus pocus – not because it is 'magic', but due to the fact the reason it gives any proposed advantage is because so many other people use it. Hence it tends to self reinforce as more people and institutions (over the years) use it. To that end, why does a 200 day moving average matter… but not so a 137 day (or 253 day) average? Perhaps Fibonacci retracements can be better argued as not being "hocus pocus" as
they are found widely through other disciplines but you get the drift; of course this is only my opinion and I am sure could be argued strenuously by others.
"TA" does not seem to be used very much at all anywhere in the mutual fund world (I don't think I've read more than 5-6 stories in 15+ years about it's use in the mutual fund world) but is much more prominent among the hedge fund and non mutual fund institutional set. While some people ONLY use technical analysis and nothing else, I think it's best used as another tool on the tool belt, but to each their own.
Via Greg:
What it is
Technical Analysis at its base
is an interpretation of price action plain and simple. It can be interpreted in many ways. Some use resistance and support levels based upon previous points where an asset has struggled to move higher or lower. Some use trend lines that rise or fall to glean insights into changes in buying and selling sentiment. Many look at historical patterns like triangles, wedges and channels to try to estimate how prices will react going forward. Still others look for cycles and patterns like Fibonacci ratios, seasonal factors, election cycles and longer cycles like Elliott Waves and the Kondratieff Wave for an explanation. It can get quite complex with derivatives of the price action in momentum oscillators and volatility measures. Volume can play a role as well as an indicator appetite. But
no matter what tools they use all technicians are looking for an edge to give a good entry or exit on a risk reward basis for a deployment of capital. A risk framework to design a trading strategy around. A forecast. A possible future with contingencies.
What it is not
This is a subtlety many that do not practice TA fail to grasp.
A possible future with contingencies. There is nothing about certainty in that statement. TA is not a road map. It does not point to an outcome. Probability is more like it. It is not fixed in time either. The read can change with changes in the price action, expected or unexpected. Nothing is certain. It can change with time. The closest thing to certainty in the TA world are horizontal support and resistance lines. They do not change, but they are also not made of concrete. Price can just as easily blow right through them or gap over them as it can be halted. And what has worked in the past may or may not work in the future.
