What is good technical analysis?

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Technical analysis is used by most individuals investing in financial markets. If you publish some analysis on the net, your analysis is judged by other traders. But on what points can we really judge technical analysis’ quality? What good technical analysis?

Criticisms of technical analyses that are often unfounded!



For most people, technical analysis is considered good as soon as the scenario established by the analyst is realized. The most demanding even go so far as to wait until the objective is reached to validate the technical analysis. For this reason, technical analysis is highly criticized.

Let me tell you that this reasoning is absurd. The quality of technical analysis is not judged after the fact, but at the time of its publication (before the scenario is finally completed). Technical analysis is not judged retrospectively but in the present.

On almost all forums, you will notice that people leave comments on analyses once they know whether or not the technical analysis scenario has completed. To sum up, it's "Congratulations, Well done!" if the scenario comes to fruition, and "Get lost, You're useless!" (to be polite) if the opposite scenario happens.

I'm not saying don't put a comment after the fact. If you discover the analysis too late, you could very well put a positive comment on the analysis (that always pleases the analyst). You could also put a negative opinion (if it is justified and based on solid arguments), but if it is to make basic criticism to underline the fact that the opposite scenario happened, pass on by!

If you read analysis just after its publication, you have the right to disagree. But at that point, you should tell the technical analyst and explain why in the commentary. Not all traders have the same market vision, or use the same trading strategies, it is therefore normal not to agree on everything. When you criticise, you have to consider it an exchange of ideas and not confrontation. You should try to explain your point of view to the analyst and try to understand his technical analysis.

Technical analysis is a matter of personal commitment



I have an example that shocked me deeply a few months ago with the SNB. Nicolas Chéron (then at FXCM) predicted the rise of the EUR/CHF pair (which was then on its low point). In the end, the minimum threshold yielded and we all know what happened next. Nicolas was then severely berated on social networks and some individuals even went so far as to sue him personally.

This example reflects the state of mind of many individuals who have a totally distorted view of what technical analysis is all about. When the technical analyst accurately predicts the facts, they find it normal, but when he has the misfortune to make a mistake, he is incapable. Moreover, there are more nasty comments on the web than thankful comments on the various technical analyses. The boursorama forum (but it is by no means the only one) is the most striking example of the stupidity that some individuals can show.

Be aware that a technical analyst makes mistakes on a regular basis and this is normal. Technical analysis is there to give a situational analysis, at a given time, on a market situation. The analyst then studies resistances / supports, chart patterns and various technical indicators based on his trading strategy, and seeks to determine the most likely scenario(s). But in the end, we must never forget that it is the market that has the last word. You can have a configuration that in 90% of cases is bearish but the market can decide to choose the 10% of cases where, in the end, it is a bullish scenario that occurs. Was the analysis wrong to recommend a decrease? No. At the time he published his technical analysis, he was right to think that this scenario would prevail.

The difference between a scenario and a signal



With technical analysis, individuals rarely distinguish between a scenario (the analyst's feeling based on technical analysis tools) and the signal validating that scenario. For this reason, it is not possible to analyse its quality.

Let's take a simple example of a double top chart pattern. The price comes to the pattern’s neck line. It is therefore logical to assume that a decrease will occur based on probabilities. Indeed, in 83% of cases, there is a bearish exit with this type of pattern. The analyst therefore establishes a bearish scenario, but at the time the analysis is published, the signal has not yet been given.

What validates the fact that we are in a double top case is the break in the neck line, that is what gives the bearish signal. As long as the neck line is not broken, the technical analysis scenario is sort of on hold. If the break does not occur, it does not mean that the analyst was wrong. It is simply that his scenario was not validated and that the position was not taken because the bearish signal was not given.

In a case like this, you will see many individuals criticizing the analyst by telling him that his scenario was totally wrong. Well, no, his scenario was the right one at one point. It is only after the price rebound that we can say that it was not a double top. The technical analyst was not mistaken because the signal was not given. The market has just decided not to validate his scenario. For many, this distinction between scenario and signal is difficult to make and this is what leads some individuals to react foolishly on the forums.

What is good technical analysis?



Let's continue with our example of the double top. Let's assume this time that the sales signal is given with the break in the neck line. Does the analysis become good technical analysis at that time? Or must the price objective, given by the analysis, be achieved? What happens in the event of a false break? What if a rebound occurs before the price objective?

The important thing with technical analysis is not that the scenario is achieved and the price objective is achieved, but that you clearly identify the elements that enable you to open a position, determine relevant entry points, and highlight potential objectives.

Once your analysis is done, it is the market that decides and you can do absolutely nothing to control or anticipate it. Technical analysis only tells us, if this signal is given, there is a high probability that this level will be reached, that's all. The fact that the signal is given does not guarantee that your objective will be achieved. That's why once in position, you need to stay active. As time goes by, you have new information for your analysis and you must therefore draw the right conclusions (early profit taking, exit from a loss-making position, move a stop loss, etc.). But all this is trade management. That is why we cannot analyse technical analysis (see When toanalyse technical analysis?)

Trade management and technical analysis are two completely different things. Admittedly, trade management can be based on elements of technical analysis, but this must be distinguished from the analysis part. Trade management is trading and technical analysis together, it is the preparation for trading under good conditions. There is no one element more important than the other, they complement each other. If you do good analysis and manage your trades well, you earn money. If you're only good in one area, you'll lose some.

Conclusion



Good technical analysis is above all about being able to identify entry points and price objectives. To do this, you can use the full range of technical analysis tools (indicators, patterns, etc.). A technical analyst only establishes scenarios that are most likely at a given time, that's all. Bad technical analysis is only a bad use of the tools but it is in no way related to whether or not the technical analysis’ scenario occurs. You must distinguish between signal and scenario. Once the signal is given, you enter the trading phase with trade management. With the same analysis and signal, two traders can have a completely different result. Welcome to the world of trading!

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