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Do Technical Indictors Actually Work?


The argument against the effectiveness of technical indicators in stock trading revolves around several key points:


1.       Condition Dependency: Indicator-based strategies are highly dependent on market conditions, making them unreliable in most scenarios.  An indicator that works well under certain market conditions might not perform as expected under different conditions.  Some indicators are dependent on trends, others for volatility, or volume while others are dependent on the time frame viewed.  What works on a 30 min chart may not work on a 5 min chart and vice versa.


2.      Distraction from Price Action: Relying solely on indicators can distract traders from the essential price action on charts, leading to less effective decision-making.  Understanding the behavior of Price Action leads to predicting future price action.  One simple aspect of price action is mean reversion and to the extend that indicators can help with that there is a case to made, but that’s it – and that’s not nearly enough.  Price action has a lot more to tell  -- if we study it.

 

3.       Overcomplication: Traders often overcomplicate trading by using multiple indicators without a clear understanding, leading to a distraction from price action, confusion over the meaning of a signal and poor results.

 

4.      Misuse and Misunderstanding: Many traders misuse indicators, deriving meaning without fully understanding the underlying mathematical or statistical derivation of the indicator.   

 

5.      Used against retail traders: The Indicators that are most commonly used can be guides for institutions with the largest trading volumes to gain visibility into when retail traders are more likely to buy and sell – leading to price manipulation.

 

 6.      Indicators lead us rely on emotion:  Since there are so many indicators and so many time frames with which we can view these indicators we can adjust the picture to see virtually anything we want to see.  This leads us to fall prey to confirmation bias where we adjust the ‘facts’ to justify whatever outcome we desire most.

 

7.      Signals are just a mirage: The same buy / sell signals that are created by indicators can occur on synthetically created price charts.  Patterns such as gaps, head and shoulders, moving average crosses etc., are naturally occurring and will be evident in a price chart derived from completely random price data which obviously has no predictive significance.

 

8.      There is no quantifiable data:  There is a lack of data on the effectiveness of any technical indicator. 

 

  

Conclusion:  You can make money in the markets using technical analysis, just as you can by picking stocks at random, throwing darts at a dartboard, or tossing a coin to decide which to buy or sell – i.e. by dumb luck.  But you can’t reliably make money this way. 


Technical indicators can have some value as a confirmation tool when looking at mean reversion with moving averages, when used correctly as part of a broader Quantitative strategy with an edge.  One must avoid their misuse, overreliance, and be aware of their inability to predict market movements accurately and consistently. 

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