Many traders use technical analysis for trading stocks. Technical analysis is very attractive because it is based on math and statistics, thus giving the illusion of accuracy and predictability. However, technical analysis has several flaws and traders should be aware of its limitations.
These disadvantages include:
1. At their heart, all technical indicators - no matter how complex - are based on price, which always reflects what has already happened in the market. Thus, technical analysis is reactive - not truly predictive of what will happen.
2. Today's markets are much more chaotic and choppy compared to previous decades. This is because of hedge funds and computerized ultra-stockstackup.com" title="short term trading">short term trading activity. The result is more false signals and ill-formed patterns from technical analysis techniques.
3. The bulk of technical traders still rely on a handful of indicators first created in the 1970's. This results in their overuse and, thus, the markets adjust and render them less effective.
4. The majority of technical traders attempt to do trend-following. While trend following techniques can make big money over time, they have a low accuracy rate and a high draw down (most trades are losses and its not uncommon to be down 50-60% at some point). Most traders can not handle this psychologically. They end up overriding stockstackup.com" title="Trading Signals">Trading Signals and/or switching between systems.
5. Classical trading chart patterns can be found in graphs of non-market related activities, including temperature charts. Also, chart patterns can appear and disappear depending on the scaling of the chart. This strongly suggests that chart patterns are a trick of the human eye and have no predictive value.
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