Wednesday, December 28, 2011

Trading Based on Classical Chart Patterns is Modern Alchemy

He can kiss his CTA goodbye.
From the Price Action Lab Blog:
Medieval alchemy aimed, amongst other things, at the transmutation of base metals into gold. Trading based on classical chart patterns, like triangles, head and shoulders, pennants, etc. is a form of modern alchemy because it aims at the transformation of simple geometrical shapes found on price charts into trading signals that generate profits. This fact alone does not imply that chart pattern analysis is useless. This type of analysis has different uses for different people, depending on their level of expertise and even investing power.
Whooboy. There goes the invite to the Society of Technical Analysts confab.
Why Chart Pattern Analysis is not a science
When traders study chart patterns they are never sure of the final outcome. Specifically it cannot be known in advance whether a chart pattern is a continuation or a reversal pattern. This can only be known on hindsight. Furthermore, the phenomena observed, i.e. the geometric formations on charts due to price action and subsequent prices moves, are not reproducible in a laboratory and thus the outcomes cannot be verified.
These facts contribute to the main reasons for chart analysis being more of a “modern alchemy” than science. In the macrocosm, there are laws that are confirmed experimentally and given the same initial conditions, the same phenomenon emerges with very high probability, almost certainty. For example, the law that objects fall to the ground with acceleration independent of their mass, the principle of Universal Gravitation, has been confirmed with accuracy of one part in a trillion in recent experiments. With chart patterns, given the same principle and initial conditions, different phenomena may emerge, for example an uptrend, a downtrend, sideways action or any combination thereof. This implies that any efforts to turn chart pattern analysis, or essentially the application of naive geometry to the study of price action, into a tool for profiting resemble those old attempts of turning chemistry into a tool of wealth by converting cheap metals into gold, known as alchemy. This is one reason we cannot also talk about rigid principles of technical analysis or founding principles. There are probably as many principles as presumed or self-proclaimed founders.

Chart analysis is not useless but it can be dangerous
The above stated facts by no means diminish the value of classical chart pattern analysis. It is only downgraded from the status of a science to the status of an art, if I may call it that. This further means that any gains from such analysis depend on how the individual who is using it perceives reality, her experience, intelligence and even investment power....MORE
Now AAPTA would like a word....