The debate between technical analysis and fundamental analysis has been one of the most attention-grabbing debates in the investment world and has led many professionals in the industry to question if technical analysis actually works. Why is technical analysis unreliable? Should you use it at all?
In this article, we will go over the main reasons why technical analysis does not work, despite its benefits, and why it is important for investors and traders to focus on fundamental analysis instead.
Why is technical analysis useless?
Technical analysis is not entirely useless, although the advantages of using it as the sole basis for trading or investing decisions are scarce. Here are the main limitations of technical analysis that can be considered useless:
- Highly subjective
- Highly inaccurate
- Unreliable over the long term
- Reinforces pre-existing views
- Basing investment or trading decisions solely on patterns does not work
- Algo trading has changed the interpretation of price movements
Subjective and inaccurate
Firstly, it is important to mention how subjective technical analysis is. It is a pseudoscience that relies on the interpretation of chart patterns. Two distinct individuals might look at the same chart and have completely opposing views. This makes it difficult to use technical analysis as the only source for an investment or trading thesis.
Due to being subjective, two technical analysts might look at the same chart and have completely opposite views. Therefore, using technical analysis seems to reinforce the pre-existing views of the technical analysts using it. Technical analysis certainly has important uses, however, it is too subjective to be relied upon over the long term.
Before the introduction of AI trading, and HFT trading, technical analysis could be used as a proxy for investor sentiment towards a certain stock or asset.
However, today's price action is not dictated solely by investors' emotions or views on a particular asset. It is rather influenced by algorithms trading these same patterns. Algo trading represents roughly 70% of all the trading volume in US markets. Therefore, although you can still identify some patterns on charts, trying to rationalize these small price movements that are mostly noise becomes extremely difficult.
Unreliable over the long term
Additionally, technical analysis does not tell you anything about the asset. In order to make a fundamental investment decision, you want to make sure you understand where you are putting your money into. Making investment decisions with large sums of money solely based on price patterns is useless.
Another reason why technical analysis might be considered useless is that expert traders rely immensely on fundamental analysis in order to trade. They conduct their independent research and use technical analysis as an auxiliary component to set up their trades.
Does technical analysis actually work?
Although some technical analysis strategies have worked in the past according to a study on the matter, today the results of this approach seem to show mixed results. Day traders and short-term traders still rely heavily on technical analysis, however, there is no single strategy to follow that can work over the long term.
Even long-term investors might use technical analysis to some extent, in order to find the right entry point for an investment. However, their decisions are not influenced by it, and it is solely used when combined with fundamental analysis.
What is wrong with technical analysis?
The main problem with technical analysis is that the same strategy cannot be used consistently. This means that traders using it have to constantly adapt their trading strategies in order to use their technical analysis consistently.
It also becomes difficult to use it as a basis for trading due to being unreliable.
Why do people hate technical analysis?
There are some people who hate technical analysis, but it comes from skepticism. Since it is incredibly difficult to predict the stock market, most investors and traders feel that technical analysis is a form of pseudoscience that tries to justify market noise or small movements that might not have any justification.
Do professional traders use technical analysis?
Yes, most professional traders rely on technical analysis as part of their research and due diligence process. However, they do not base their trades solely on technical analysis and use a combination of fundamental and technical analysis.
Does Warren Buffett use technical analysis?
No, Warren Buffett bases his investment decisions on fundamental analysis. His goal is to value stocks and to buy them at a lower price than what the valuation implies.
Does Peter Lynch use technical analysis?
No, Peter Lynch uses fundamental analysis as the basis for its investment decisions. By reading Peter Lynch's quotes, as well as his books you will find that most of his investment process relies on researching companies, and trying to value them.
Is technical analysis useful in Crypto?
If you are day trading crypto, technical analysis can be useful. Traders may use it to predict price patterns and determine whether a certain cryptocurrency will trade higher or lower. However, it can be unreliable, and it is difficult to be a profitable trader over the long term by simply relying on technical analysis.
Is technical analysis worth learning?
Yes, it is important to learn some of the most basic concepts of technical analysis. As it can help you determine what are the best entry points for an investment or trade, as well as the exit points. Both investors and traders might use this to their advantage.
Is fundamental or technical analysis better?
If you are an investor you should rely on fundamental analysis, since nobody makes investment decisions based on price patterns. However, if you are a short-term or day trader, it makes more sense to use technical analysis. Overall it is important to use both types of analysis whether you are investing or trading.
How often is technical analysis correct?
It depends on the technical analyst that is making the predictions. Since technical analysis is such a subjective topic, two analysts might look at the same chart and have completely different views. Therefore it is difficult to say exactly how often technical analysis is correct.
Is technical analysis enough for trading?
Although some traders just use technical analysis, in order to improve your trading skills you should also develop your knowledge of fundamental analysis. Just using technical analysis does not work. In order to be a successful trader, it is important to learn as much as you can. This is one of the reasons some traders fail because they only rely on one market approach.
We have seen the shortcomings of technical analysis, and how using it over the long term can be very unreliable. It is important that investors and traders understand that knowing both fundamental and technical analysis is crucial to being profitable in the market. Whether you are day trading or you are investing for the long term, both approaches can be helpful.