The Importance of Technical Analysis in Trading

Trading the financial markets, be it equities, forex or commodity futures has always fascinated both investors/traders and the general layman as well, largely thanks to the news clips and media attention it gets of ‘overnight’ millionaires, savvy hedge fund managers. While the spotlight has managed to work as a bait, the dark side of investing/trading often gets meager attention and in most cases always carries a reason behind it. Be it a flash crash or an investor sell off.

What most mainstream media fail to focus on however is the aspect of technical analysis that often forms the pivot for trading decisions which eventually determines the outcome. Sure, speculative trading is only as good as predicting the weather. One can only assume but never be too sure.

The debate of using technical analysis as a tool has given rise to many research papers and well known books. On one hand, you have a group of investors who prefer to focus on the fundamental factors while on the other there are hardcore Chartists or technical analysts. It is no wonder that the above debate has given rise to some well known financial theories, each often disputed by a new finding. Examples of these include the ‘Efficient Market Hypothesis‘, ‘Random Walk Theory‘ and so on.

Technical Analysis – Should you ignore it?

Before we get around to answering the question, one must ask what is technical analysis? The most commonly agreed upon definition of Technical Analysis is the aspect of studying charts, looking for potential price patterns or scenarios in order to predict future price movement. Technical analysis can be summarized as the biggest critic of certain well known financial theories, especially the ‘Random Walk

Theory’ which postulates that prices are unpredictable, to put it bluntly.For most traders, irrespective of the markets they trade, technical analysis has grown to be a powerful tool. A case in point is the rise of many established and in some cases, respectable schools that claim to teach you how to apply technical analysis to your chart study and can also be widely seen by many forex brokers that hire teams of technical analysts whose sole job is to study the charts and recommend trading ideas for their clients.

Technical Analysis and the Trader

So if you were asked the question whether you should pay attention to technical analysis or ignore it completely, the answer to that would be subjective and takes into account various aspects. For a long term investor, technical analysis such as support and resistance levels does not make sense simply because they are in it for the long haul. But on a same note, mention support and resistance to an intraday trader and the response would be different, if not attentive. Therefore, depending on the category of traders the above question is asked, the answers can vary.

Technical Analysis has grown to be an important part of trading, especially for the retail trading community given that most of the traders in this segment fall under the category of intraday traders, meaning those who hold their positions from a few hours (or minutes) to a few days or weeks at the maximum. Within this subset of traders, if one digs deeper, we can find different schools of thought; Elliotticians (the practitioners of Elliot Waves), Pure Price Action Traders (trading simply off candlestick formations) are some of the examples.

To conclude, Technical Analysis forms an important aspect of a trader’s toolkit alongside the fundamental news which sets the tone. Given the different objectives that vary from a long term investor to a short term trader, the importance of Technical Analysis also varies. However, as a retail trader, it is quite clear that one simply cannot aim for continued success in trading by ignoring technical analysis, the fact that many (retail) traders make use of Fibonacci levels or counting Elliott waves proves that you cannot go against the flow, such as placing a SELL order at a 38.2% retracement level when just about any Fibonacci trader would be looking to BUY at that very price point.