Technical analysis has been around since as far back as the old Assyrian period when traders would gather in Karums. Modern technical analysis, though, was first popularised in the US by Charles Dow in the early 20th century before becoming mainstream in the ‘60s and ‘70s with the creation of modern technical indicators.1
Unsurprisingly, therefore, understanding how to use these technical indicators became an essential part of any trader’s repertoire with many relying solely on them to find trading opportunities. However, these tools also have a multitude of flaws which make them unreliable as a guiding light in the financial markets, which you ought to consider before choosing them in your own trading.
Markets are unpredictable
Technical analysis works primarily on the assumption that history repeats itself. Based on this premise, technical indicators are used to identify trends and patterns in the market, which are then used to predict future price movements.
Nowhere else is this more common than in the forex market where traders have to make quick trade decisions in a fast-moving industry. For instance, the chart below represents the most basic market cycle used to find the most ideal conditions to enter the market and which direction to trade. 2
Despite the successes enjoyed by traders using this system, it has also been heavily criticised by various market experts. One of them is Burton Malkiel in his 1973 bestselling book – A Random Walk Down Wall Street. In it, he claimed that markets move at random, hence there isn’t a way to predict specific entry and exit points. 3
That was Malkiel’s primary observation in the book and there have been a myriad of examples of this happening all through history when certain events broke predetermined patterns. Whenever this happened, technical indicators proved worthless. Moreover, trading signals and expert advisors (EAs) that use historical price data and patterns are not accurate in the long run because of this reason.
Indicators make trading more complicated
Knowing that technical indicators are not always reliable, traders have to find additional sources of information to justify their decisions. One way to do this is by complimenting each indicator with one or more others to firmly establish a perceived pattern that could be more reliable. Once again, this strategy is most widely used by forex traders who have multiple indicators to choose from on trading platforms.
In the chart above, we added 3 of the most popular technical indicators to a price chart, and you can already see how cluttered it has become. And that’s long before getting into each indicator’s individual parameters, created using different complex arithmetic functions, and then learning how to study each one separately before you’re able to extract accurate information.
All this results in a steeper learning curve especially for beginners. Even seasoned traders sometimes become overwhelmed by the variety of options, choosing instead to stick to a few indicators they understand well. But that’s the sad thing… because most traders don’t get to maximise the utility of these indicators.
They distract from actual market activity
Because technical analysis is focused on studying charts, it tends to neglect IRL factors that may affect the markets. When this happens, you may be caught unaware when important market news strikes that significantly disrupts existing chart patterns and trends. A good example of this can be seen in the first quarter of 2020 when the global pandemic hit, sending the markets into a unique spiral.
What’s important to note is that this wasn’t the first time such an event occurred. For instance, when the Swiss National Bank (SNB) depegged the franc from the euro, the currency soared 30% against the euro and 25% against the US dollar within minutes. It made such an upset in the markets that cost most technical analysts money, including some major online brokerage firms.
Here we can see the sad truth about technical indicators because they simply cannot account for the latest market developments while using historical data. This is not to say that the indicators are unreliable, though, but simply to point out some of the limitations you have to factor in whenever you load a technical indicator onto your trading chart. It should remind you now to become too dependent on these tools in your trading and, most importantly, not to forget the fundamentals of the financial markets.
Multiple technical indicators result in confusion
The technical indicators we use today have been developed over several decades since the introduction of technical analysis. Each one was developed by a different market expert, usually from different global locations, based on their individual interpretation of market patterns. What we have, then, is a wide variety of indicators that sometimes present varying results.
This is so common among technical indicators that most of the more complex indicators available in trading platforms are an amalgamation of several individual indicators into one. Examples such as Bollinger Bands and the Ichimoku Cloud combine popular indicators such as moving averages and RSIs to create a more effective tool.
Technical indicators can have varying interpretations
Technical indicators are generated mathematically, which means that they should, in theory, be similar on all trading screens around the world. But they’re not. The main reason is that, as briefly mentioned earlier, they can be modified using different parameters to match a trader’s goals and strategy. Therefore, the same indicator such as the simple moving average in the chart below can have different results. 4
But even when the same indicator is used with the same parameters, it’s up to the trader to decide what the data reveals. For example, below are two trend lines on the same chart, each one showing different information. That is because traders have to make individual decisions on what and where they think the indicator should be placed.
The result is a mix of different findings that often result in heated debates on trading forums and blogs, which show just how divided opinions can be. It’s another sad reality of technical indicators, but fortunately, one that can be resolved simply by staying patient while trading. A little patience can confirm the findings of any indicator thus helping you avoid becoming a victim of false breakouts or trend reversals.