If you have read any of my other work on how I trade, you will know I’m not a fan of using charts to predict the future. I am not a technical analyst trader. Definitely not a fundamental analysis trader either. The latter makes even less sense for an active trader these days. You simply can’t compete with the firms paying millions of dollars for data seconds before everyone else.
On the face of it, charting makes a bit of sense. Looking at the history of a market may help to explain the events that happened. What it doesn’t do is help you predict the future with any great accuracy. Nassim Nicholas Taleb says it best in his book Fooled By Randomness. With the effect of the hindsight bias, “those who are very good at predicting the past will think of themselves as good at predicting the future, and feel confident about their ability to do so.” If you aren’t aware of the hindsight bias, it is as the name suggests. An overestimation of what one knew at the time of an event due to subsequent information.
Interpreting the chart is far from technical.
Human biases don’t help when doing technical analysis. If you are looking for a wedge, cup and handle, head and shoulders, reversal or flag, then quite often you will find it in the chart Thereby feeling confident you have confirmed you intuition. The problem is if you show the chart to someone with a different take on the market then they might not find the same pattern. This leads them to a different prediction.
So whilst the name might be technical analysis. The only technical part is the chart itself. Interpreting the chart is far from technical. Adding a trend line is the closest to being technical. The number of ways to add a trend line is a problem. Over what period, average, weighted average, straight, logarithmic?
In the words of Andrew Aziz a day trader and author, you will find yourself identifying a bullish or bearish pattern depending on whether you are in the mood to buy or sell. It is kind of like the Badder Meinhof principle. If we think about a red car, then all of a sudden we notice how many read cars are on the road. If you being your analysis with the idea it’s probably a market that favours short selling, then you are likely to to an indicator for a short selling opportunity.
Thoughts about reducing bias
- What can you do to reduce the effect of biases?
- Have you ever been so confident in a prediction that turned out to be incorrect?