Weaknesses of Technical Analysis
Analyst Bias
Technical analysis is subjective, and it may reflect our own prejudices, just like fundamental analysis does. Understanding these biases is crucial when examining a chart. The analysis will be overshadowed by a bullish bias if the analyst is an eternal bull. Alternatively, the study will likely be bearish if the analyst is a frustrated perma-bear.
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Open to Interpretation
The fact that technical analysis is interpretable lends credence to the bias claim. Despite the existence of standards, it is common for two technicians to view the same chart and perceive two distinct scenarios or patterns. Both will be able to sustain their positions with logical arguments, levels of resistance, and significant breaks. Although this can be annoying, it should be noted that technical analysis, like economics, is more of an art than a science. Is it a half-full or half-empty cup? Everything depends on the individual.
Too Late
It has been said that technical analysis comes too late. A significant amount of the motion has already occurred by the time the trend is recognized. The reward to risk ratio is low following such a big shift. One specific critique of Dow Theory is lateness.
Always Another Level
There is always another “important” level nearby, even after a new trend has been discovered. It has been said that technicians never take an unqualified stand, instead choosing to sit on the fence. Even if they are bullish, their opinion will always be qualified by some level or indication.
Trader’s Remorse
Not every technical pattern or indication is effective. As you start learning technical analysis, you will encounter a variety of patterns and indicators with corresponding rules. For example: When a head and shoulders pattern’s neckline is broken, a sell signal is sent. Despite being a norm, this is not always the case and can be influenced by other variables including motion and volume. Similarly, what is effective for one stock could not be effective for another. For IBM, a 50-day moving average could be ideal for determining support and resistance; while, for Yahoo, a 70-day moving average might be more effective. Despite the fact that many technical analysis concepts are universal, every security will have unique characteristics.
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