Should you use technical analysis when investing in stocks? Many traders rely on technical factors when researching stocks, and countless software programs exist that can aid in researching based on technical analysis. But should you trust it? Here are a few reasons that technical analysis should be approached with caution.
Past Versus Future Results
You’ve no doubt heard that past performance does not indicate future results. This wisdom also applies to technical indicators. Remember that any chart you are looking at shows you data from the past. Using data from the past to forecast future prices is hard if not impossible in most cases.
Hindsight is the tendency for humans to project the past into the future. Hindsight occurs in all facets of life, not just trading. You’ve probably heard that hindsight is 20/20. This can be dangerous when you look at a chart and try to project past patterns or results into the future.
There are lagging indicators and leading indicators that traders use to track stock prices. Without getting too technical, these indicators will often throw false predictions in certain scenarios.
A common false signal occurs during the middle of the day when volume is lower. Lower volume makes it easier for traders to move stocks in one direction or another unexpectedly. This can cause indicators to falsely predict a trend in a stock.
There are lies, there are damn lies, then there are statistics. Mark Twain popularized this phrase, although it is unclear where it originated. But it holds true when looking at stock charts.
Depending on how a chart is set up or scaled, it may tell a completely different story. It also depends what part of the chart you analyze. An upward trend to you may look like a downward trend to someone else depending on how they are looking at the chart.
Technical analysis says that stock price is a reflection of investor mood. What technical analysis cannot account for is when a large amount of money enters or exits the market via a hedge fund or institutional investor. Large sums of money are moving the markets today more than investor sentiment.
Lack of Proof
The academic world will argue that the outcome of technical analysis is no better than picking stocks at random.
What is an Investor to do?
Should you use technical analysis when investing in stocks? Yes, you should. Just don’t rely solely on it. Technical analysis should be looked at as a tool to help guide you in your trading career. Analyzing a stock is always good practice, as you don’t want to invest in something you know nothing about. Just don’t blindly trust the data that the charts are showing you.
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Writer and Investor. Based in the Pittsburgh, PA area, Brian holds full-time employment as a Warehouse Manager for an electronics firm. Brian enjoys wealth building, investing, gardening and the great outdoors. Brian holds a B.A. in Environmental Studies from the University of Pittsburgh and an MBA from Robert Morris University.