Winning Edge Trading: Successful and Profitable Short- and Long-Term Trading Systems and Strategies

CHAPTER 8

Technical Analysis

Technical analysis enables traders to identify potential shifts in a security’s price behavior, including the start of a new trend or the end of a long-lived trend. If a security has been advancing and making new highs, for example, the trader is poised to project its turning point—an overbought condition of the security—at which point he can sell his positions, protect his profits, and create a much better return in the end.

Using technical analysis doesn’t necessarily reject the value of fundamental analysis, however. Technical analysis proposes that each single price point is a reflection of market participants’ cognitive and emotional decision-making points. Investors gather all the available information and project their opinions into the price behavior. Thus the market as an aggregate of all market participants with all available interests and opinions becomes a discounting system for possible price action of a security. However, technical analysis opposes the Efficient Market Hypothesis (EMH) notion that market participants who look for trends or any order in the market simply tread water. Conversely, the proponents of EFH proffer that any shift in market fundamentals is reflected in the market immediately due to its efficiency. Therefore, there is no advantage or benefit for traders to look for a trend in the market, since there is no trend.

According to EMH, the market is trendless and exhibits random price movements. However, technical analysts ...