What is technical analysis ? It is not an obvious question and there is also no obvious reply. To start thinking about this topic we need to ask ourselves if Wall Street works today as it was used in 1907. In those times there was no free real time information and over all trading was done on open outcry. Now everything is electronic. So would you apply the same all tools born 100 years ago to the today markets ? Do you want to kill yourself ? Please do it.
Markets change, traders change, trading methods change. Technical analysis was not a science up to when computers become available to everybody and traders started to test and verify the trading methodologies. Before that technical analysis was a practical methodology derived from experience, nothing scientific at all. After computers became available to everybody technical analysis underwent to a more and more pronounced process where at the bottom it became a science. Like medicine or physics now traders request to a trading methodology that it must be tested and it should respect all the requirements of the scientific process. This is what I call “modern technical analysis”, to be distinguished from “classical technical analysis”, that is what you usually learn in the famous handbooks like Pring or Murphy.
Does it have any sense today to still use methods that have no scientific confirmation ? No, everybody has a computer on his desk so why to believe to what you cannot prove ? This is the big distinction between “classical technical analysis” and modern technical analysis.
Let’s make a concrete example: you will sure know what is Point & Figure methodology and its forecasting capability. To present Point & Figure as a mystical trading methodology would be false since it was at the beginning of the last century a simple price registration method. Since Point & Figure tracks just the significant moves of the market it was easier to track the daily movements of the markets with a manual work of writing, much different than recording all the single little movements and even those without any signification. So what is the reason to use today Point & Figure ? Today when we have a computer that can cheaply and swiftly records all the prices and make charts in a fraction of a second. Does really Point & Figure has much more forecasting capability in its classical interpretation than a whatsoever momentum strategy ? Aren’t we talking about the same thing ?
At the end of last century I went to visit in New York an 80-years old trader who was recording on a wall paper every day a 45 minutes point and figure chart. He wrote in 40 years so many papers around the wall that this one was 30 centimetres thicker. But he could easily performs the jobs because in a dull market there were no points and no figures boxes to draw in a full day so that it was a job that could be possibly done by a human being. This little story will tell you really what is point & Figure, a price recording technique invented in 1800 for ease the trader’s work.
Let’s make another example: trendlines. How many ways exist to draw a trendline ? As many as the traders that are drawing them. Usually traders will draw a trendline from left to right if they want that the trendline will fit properly the price series but they really will have little action and no useful forecasting power. Traders anxious to place the next trade will draw a trendline from right to left so that the entry points will be very close even if the trendline will not fit all the cart prices. There is no unique way to draw a trendline so that the only possibility to know which one is the best is to test it on a computer.
This approach will lead us to the final question: trading is an art or a science ? Consequences are serious. If trading is an art there is no way to learn it, you just can be born as a successful trader, and we stop here. No seminars, no books, no magazines. If trading is a science it can be taught since there is the old hypothetical – deductive method that science commands to distinguish in between good and bad technical analysis.