Does Penny Stock Technical Analysis Work?

The Flaw in Technical Indicators - Why Skill and Luck Matter

Yesterday one of my trading challenge students hypothesized about potential flaws regarding fundamental analysis on stocks, today he’s back with more warnings on the downfalls of technical analysis.

Once you read the post below you’ll see this guy is VERY philosophical, I love it!

You beginners out there probly won’t even understand this blog post, for you, just focus on the indicators that do work as I explained them HERE and HERE…I’m not right every time, but my winning percentage of over 80% the past year is due specifically to my using these indicators and trusting them.

Here’s this guest blog post:

Skill is more important than luck, just for anyone thinking that there is a debate to be waged there. All traders and investors must respect luck, but luck just happens. All your time should be spent honing your skill not buying rabbits’ feet. Leave the rabbits and their feet alone, what did they ever do to you? Heading off that issue let’s talk about the flaws in technical indicators and why two people can look at the same type of information and one of them can consistently do better.

Skill as a Trader and Analyst

Before delving into minute differences in the way people perceive and process the same information, note that being great at technical analysis or any analysis does not make you a good trader. There are plenty of traders all over that are spot on with their general trades, but bungle the details. They sell too early, even if they knew they shouldn’t. They execute a trade perfectly, but went with too small of a position size. Or they simply got too lazy monitoring and were napping when the event they predicted occurred.

There can be a lot of reason that a trader can be great at picking them, but bad at winning them. A lot of stems from self doubt, but some of it can just stem from not knowing any better. How many new traders spend a ton of time finding that golden trade? Or at least learning how to find that golden trade?

Reading charts and looking at MACD and RSI indicators will not help them execute the trade properly. It will only help them find a trade to do. It is just as important to manage your position properly at it is finding the right trade. Perhaps not just as important but it is more 60/40 than 90/10. Do not neglect the actual action of trading, because that can mean the difference between an overall winning record and losing one.

Technical Data is not Physics

The interpretation of the person looking at the information matters when it comes to any sort of stock market analysis. Technical analysis is garbed in mathematics, but technical data is all about what the market is perceiving, and there are a lot of indicators out there. It is not like solving a mathematical proof.

Two people looking at the same information can determine different things. A strong signal to one might be a moderate signal to another. Or the more experienced person might see something in another indicator that indicates a false signal. There are lots of permutations on the same theme.

A lot of technical analysis is based on the perception of the market. In reality so is the price. Fundamental analysis is based on using the underlying aspects of the company to gauge crowd sentiment. Technical analysis is using price and volume to do the same. Interpreting data about what the crowd is thinking is going to be fuzzy.

Lagging Indicators

There are almost no real leading indicators, unless you are talking about physical phenomena that will have an effect later. Even present information is lagging, because by the time you see then act it is already old information. Most indicators do not even exist that much in the present. They incorporate older information to divine a trend.

Lagging indicators cannot account for potential new information. Anything can happen that could throw off the course of a stock. Technical analysis can work, but the risk increasing the longer a trade is held based on that information. I know some traders like to fly fairly blind into trades based on strong technical indicators. It works for them after years of experience. They just make sure there is nothing scheduled like earnings that causes what they are seeing.

A quick Google search can do wonders. It is not about getting the low down on every little detail about the company, but you do not want to try for a bounce if the company is currently being attacked by regulatory agencies. A bounce might not happen if the company is going to have to declare bankruptcy due to fines. Just as an example.

Technical traders like to perform in a vacuum of pure price action not outside events. You want a stock like Mosaic from a few years ago that only had run of the mill news between earnings but would move $5 in either direction in one day. This is where skill comes in. Technicals are effective, but not absolute. Nothing is absolute. Hence the importance of being a skillful trader, and interacting with skillful traders. The knowledge share helps a lot.

Conclusion

Limitations of your tools are meant to be understood not ignored. Once you understand them you can work around them. There is no need to debate the pros of technical versus fundamental or any other debate. The focus should be on making money however you can. It is not about ego or being right in your philosophy. Use what works for you consistently, and realize that even consistency fails at times.

Posted in Basics

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  • Todd

    Great Article- very helpful!

  • Todd

    Just kidding…