Technical analysis influences the investment decision of the majority of the players in the stock market in one way or the another. Even if these players themselves are not studying charts and patterns, it is highly probable that they are reading some of the other analysis regarding bearish and bullish patterns of the stocks which they might be considering to buy or invest.
Almost every broking and trading platform offer some form of software to analyze charts, trends and conduct the technical analysis. Many of these platforms, also allow investors to buy shares directly from these charts, making it very easy for investors to invest, buy and sell stock based on its price movement.
Investment decisions were not made this way in the past. The practitioners of technical analysis were sparse, as the available technology did not support real-time data feed and investors would manually plot daily share prices on graph paper or utilize charts offered by financial publishers and newspapers. Most of these charts were based on the daily closing price of the stock, and these charts did not provide a complete picture of the daily stock price movement for the investor. It is possible that the investors were making their investment decisions based on outdated or inaccurate charts.
But today, with the advancement in computing technology, faster computers, and high-speed internet connectivity, technical analysis has become much easier to conduct. But, is making an investment decision solely by charts and trends a sensible choice?
Off-late, many investors and stock-market players are shunning technical analysis and reducing their reliance on technical analysis for making their investment related decisions. Investors and stock market players, who were profitable using technical analysis have also begun to question its effectiveness. Their stand has changed from ‘they are profitable because they use technical analysis’ to ‘they are profitable in spite of using technical analysis.’
While supporters of technical analysis might not agree to the below-mentioned facts, here are some reasons why technical analysis might not work for you:
Past Success Cannot be Equated as Future Success
As per SEBI guidelines, every IPO, mutual fund, NPO, etc. is required to communicate a disclaimer that past performance cannot guarantee future results. While technical analysis believes that the future success is linked to past performance, the SEBI begs to differ. Using charts and technical analysis tools to determine future prices from the stock’s past performance, is violating one of the most basic investor warnings issued by SEBI. No matter how intricate a chart is, it can only plot stock prices of the past. Investors need to trade in the future and not the past. SEBI understands this and tries to warn investor in almost every step, but the supporters of technical analysis do not any pay heed to this.
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It’s only natural for humans to predict the future from the past. A chart can only provide answers for the past, i.e., if an investor had invested in the stock at X price on a certain day, and sold the stock on Y price on another day, the investor might have made Z profit. The future cannot be predicted and thus, this information is rendered useless while deciding to invest in stocks.
Stock Price cannot be moved by Investor Psychology
Technical analysis believes that the price of a stock reflects the mood or the psychology of the investors at a given period. This theory might sometimes be true.
The fact is, investor psychology does not move price, money does. With the emergence of large financial institutional players and hedge funds, a single stock trade can control the stock prices. A hedge fund manager might buy or sell a share for a wide array of reasons, but their investment decision does not guarantee to create a bandwagon effect.
Charts can be Deceptive
The appearance of a price chart can rely on a wide array of factors, and they can be interpreted differently by different investors. Any changes in the scaling of the chart can drastically alter the appearance of the chart, and if an investor is used to a certain scaling and is unaware of changes in scaling, they might interpret the chart differently. These minute drastic changes interpreted by an investor as an upside price breakout can be interpreted as a breakout failure by another investor.
Limited Academic Proof on Effectiveness of Technical Analysis
At present, there is limited academic literature which proves the effectiveness and efficiency of technical analysis while making investment decisions. Most existing studies in this domain indicate that entry points and exit points discovered through technical analysis are completely random.
Technical analysis is not completely random and does hold some merit. It is a perfect tool to scan a large number of stocks to find stocks which fit within certain parameters for additional research. Also, technical analysis can be used for comparing the price movement and performance of two or more stocks over a certain period. While technical analysis has its uses, making investment decisions is not one of them.
Also, investors need to consider the fact that investing can be risky and markets and stock prices can take an unpredictable turn, irrespective of the method utilized.