Introduction to the Art and Science of Technical Analysis
■ (^) Inefficient performance in ranging markets
■ (^) Inefficient adaptation to more volatile trend action
■ (^) Inability to identify trend changes efficiently
■ (^) Possibility of negative slippage in fast‐moving markets
■ (^) Possibility of large drawdowns due to the low winning percentages
■ (^) Reduced performance caused by whipsaw action during consolidations
■ (^) Influx of trend‐capturing systems produces inefficient fills
■ (^) Ineffective back and forward testing
Finally, it is important to note that a trend in one timeframe may be a sideways
market in another.
1.7 Four Basic Assumptions in the Application of Technical Analysis
There are four underlying premises associated with the application of technical
analysis, namely:- Price behavior is expected to persist until there is evidence to the contrary.
- For every bullish indication or interpretation, there exists an equal and op-
posite bearish indication or interpretation for the same price behavior or
phenomena. - Extreme bullishness is potentially bearish (and extreme bearishness is poten-
tially bullish). - A technical tool or indicator has no real significance except for that attributed
to it by market participants.
The first premise is about preserving the status quo. It should be noted that
most technical analysis is based on a set of assumptions. Most assumptions derive
from one grand underlying premise, that being the preservation the prevailing
price behavior. For example, a trend is expected to persist until there is evidence
to the contrary. Hence a state of persistence is assumed to be the status quo. If a
cycle is identified, it is assumed to persist until cyclic failure is clear and obvious. If
the market is in consolidation, it is expected to continue to range until a breakout
is identified.
The second premise is also a fairly obvious, not only in relation to technical
analysis but also with much of life. For example, an analyst may make a case for
rising oil prices as the reason for a rise in the Dow Jones index since it is indica-
tive of increasing demand, representing evidence of a recovering economy. The
same analyst may also make a case for rising oil prices as the reason for a decline
in the Dow Jones index due to the widely held perception of increasing cost, and
hence bearish for the economy in general. Another example would be to find the
stochastics at an oversold level and conclude that the current uptrend is strong
since it is potentially or implicitly bullish. Alternatively, the stochastics could be at
an overbought level, leading to the conclusion that the current uptrend is strong
since an overbought level is regarded as explicitly bullish.