How Technical Indicators can fail

Most noob traders get over excited about technical analysis. They spend much time working out how they work and trying them out. However, the story is the same for most experienced traders: they tend not to rely heavily on technical indicators; relying more on knowledge, skill and experience. No – that’s not intuition. That’s not guessing based on experience. It’s about gaining deeper insights into market psychology.

The psychology of all punters in a share is represented by the markets – all their fears, doubts and uncertainties. We don’t know these people individually of course. Amazingly the American Markets in particular show certain trends near earnings releases. Understanding what the psychology is – the sentiment of investors, how they tend to react  collectively is ‘market psychology’. It’s played out on the charts.

Technical indicators always rely on historical data.That should seem obvious because they can’t rely on future data. Do I really need to explain this further? I shall not!

I’ve looked at only one example below of how an indicator – the Parabolic SAR – if used on its own would have led to missed opportunity. In general indicators play out what the story was. They can’t predict what will happen in the future. You may make an educated estimate using indicators sensibly. But always aim to limit losses based on a risk analysis, relevant to the timeframe over which you are trading. If trading for the longer term of weeks or months risk can be expected to be higher. The ATR can be a useful tool in this regard, but still it is only a guide.

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