Had a bit of a brain-fart over the weekend but still like this idea/way of thinking about the whole subject, so I decided to post it… Would be interested in people’s views on this perspective…
So what is technical analysis? My (very humble) opinion is that it’s like creating a map of what’s going on with a particular instrument. Why do you need a map? To get where you want to go. You need to be able to decide, based on the map you superimpose over the chart whether to accept or decline a particular trade based on risk.
It’s worth remembering again that at each given moment no-one has any faintest idea what might happen to the market next. It’s the mass decision impact movement of literally millions of other people deciding to buy or sell.
They can’t see what everyone else is doing either and are fiercely considering only their own position and unique circumstances… (selfish lizard brains running around in survival mode – lol)
You’re trying to create a probability map of the random movement of thousands of people. However, in large groups people aren’t random – in fact they are sometimes predictable or at least they will probabilistically move en mass in a certain direction. With this last point in mind we at least have a chance to move the odds of spread-betting successfully in our own favour.
How do we do this? Fierce observation of what’s actually happening without being attached to any particular opinion about a stock or share or particular market direction. An awareness of the likely probability of something recurring coupled with a risk managed approach and finally some sort of confirmation that essentially a large part of the market is in synch with your assessment. (i.e. an entry trigger)
Now, these ‘maps’ can of course get fiendishly involved… and I’ve been completely guilty of trying to read too much into a particular indicator or set of numbers. Sadly this hasn’t helped me in the past at all. You tend to start seeing the map swim before your eyes, no decisions get made and everything becomes loud and complicated. The data begins to conform to a particular bias or random piece of news you happened to see by accident.
Since you can’t predict price I suspect many people are asking the wrong question. They ask themselves “Where is the price going to go?” and the answer is no-one knows. Well, if no-one knows the chances of you or I being consistently right are quite slim!
Maybe we should instead be asking “Where is the price right now?”
To know where something is right now you have to place it in the correct relationship to other things. “Where is the price right now in relation to other points on my map?”
What are the other things that will help me figure out where I am? Levels, trends, previous highs/lows, size of bars etc. These will all have a certain ‘weight’ that affects the price right now. The decisions made by the millions of traders to get the price of an instrument to where it is now essentially creates it’s current position.
[It should be possible one day to create a statistical model that visually defines from previous probability data where the price should go next based on the influences of previous objects on the map and their effects based on probability numbers]
Look at this a different way. All the decisions you or I have made in our lives got us to where we are today. We can’t see the future however. It’s completely un-knowable and so the position of a stock or currency pair in the market in the empty space to the right of the graph is (and always will be) a mystery. However, based on the history of our own decisions (like previous price movements) and the influences of past external events we can get a ‘feel’ for how our own and other people’s future’s might turn out. If anyone has seen the film ‘The Adjustment Bureau’ then you’ll have an idea what this map could look like ;)
As a complete aside it’s possibly easier to ‘predict’ what will happen to people who’ve had more extreme pasts. Maybe this is why looking for extremes on a chart is similar in that when this does happen the likely hood of being right is higher? Possibly getting a bit too metaphysical now! ;)
Anyway, once we’ve got a pretty good idea of where price is in relation to the objects/points/levels/trends we think are significant then we at least have a fighting chance of making good (risk managed) decisions when the price gets near to a point it was at before.
Stop trying to figure out where the price is going to go next. YOU DO NOT HAVE THIS INFORMATION. All you have is where price has been and (if you’re looking properly) what happened at significant points earlier along the journey.
At point (a) something happened and price dropped hard. The reasons could be manifold and we don’t care about them anyway. If price get’s back to (a) is it going to drop again? Who knows? Who cares? All we need to make sure of is that we’re around when it happens, have a risk managed strategy to take advantage of this potentially high probability event and there’s some sort of short term confirmation that indeed, the same behaviour is happening again. Now all we have to do is manage our exit properly!
The right question is actually more likely to be, “What are the significant points on the map I’m seeing and how do they compare to and influence each other?” More on how I’m actually using this to appear later :)