Challenges to technical analysis
- Results of testing correlations between prices and runs and the use of trading rules, with respect to the weak-form Efficient Market Hypothesis, have shown that technical analysis based on past market data does not provide superior performance.
- If sufficient technical analysts are operating in a market then they will drive price moves.
- This will lead to technical analysis working, but only in the short term, since if a price move is not based on fundamentals the price will return to its equilibrium.
- If a trading rule is found to be successful, several technical analysts would follow the rule so it is unlikely to continue to generate profits.
- Trading rules are subjective. Different analysts will reach different conclusions when presented with the same market data.
When referring to technical analysts it is important to differentiate between:
- Contrarians who believe that as the market approaches peaks and troughs, investors will generally become over-bullish or bearish, and
- Analysts who ‘follow the smart money’; they wish to follow the positive sentiment of sophisticated investors.
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