From: isigmasystems@yahoo.com (iSigmaSystems.com)
Newsgroups: misc.invest.misc misc.invest.mutual-funds misc.invest.options misc.invest.real-estate
Subject: Technical Analysis Misconceptions
Date: 28 Dec 2003 22:53:38 -0800

Introduction 

At iSigma, our systems are based entirely upon strict technical
analysis. The good side to this is that our methods have worked
handsomely for us. The downside is that technical analysis is still
viewed as suspect by many. A quick examination of the technical
analysis materials in common circulation is sufficient to explain why
this skepticism is so common. This article will deal with some of the
more popular technical methods by grouping them into three categories,
data plotted on the price chart, data plotted below the price chart
and visual methods. Be advised that none of the methods or indicators
here are used in our systems.

Data plotted on the price chart 

This is the category containing the most popular indicators, including
moving averages, volatility bands, trendlines, etc. The popularity of
these indicators is most likely a product of their effectiveness. As
we explain here, these indicators can serve as the building blocks of
somewhat better than average trading systems. The reasons that these
systems are only somewhat better than average stem from the fact that
the indicators they are based on are used as proxy for the price even
though the price may be quite different. Imagine a trader calling a
broker to buy shares which are currently trading at $17 with the
moving average at $15. The trader had better not plan on buying at
$15. The broker will allow a trader to trade for the current market
price. This is the number that matters. Since the market price is
already available, why worry with the value of the moving average (or
volatility band or trendline or any of countless other chart overlay
indicators) at all?

Data plotted below the price chart 

In addition to drawing all kinds of lines and bands and averages on
the price chart itself, many traders also try to enhance their trading
by examining certain indicators which are commonly rendered below the
price graph. Within this class of indicators are momentum, moving
average convergence difference (MACD), average true range (ATR),
stochastics, %R, on balance volume (OBV), relative strength index,
etc. It's beyond the scope of this article to explain the calculation
of each of these, however they all are used very similarly. Traders
who use these types of indicators typically have rules such as "If the
XYZ indicator moves above 0, then buy some shares." This leaves a
trader in a difficult dilemma, to place a transaction without
considering the current price, or to possibly override the indicator
due to price action and sacrifice consistency. Additionally, a good
portion of this class of indicators are intended to indicate when a
trader should buy on weakness or sell on strength. This might
initially seem like a tidy way of buying low and selling high. Carried
out to its logical conclusion, this sort of thinking would dictate to
keep adding to a position as it continues to lose money. Repeat this
process enough times and the trader has thrown so much good money
after bad that continued trading ceases to be an option.

Visual methods 

In addition to the more formulaic methods listed above, there are a
host of technical methods based on visual examination of price charts.
Candlestick charts, point and figure charts, Gann angles, pattern such
as head and shoulders and the like are all examples of visual methods.
Certainly a benefit to such methods is that anyone can immediately use
them with only some brief training on what patterns to look for. This
is also the reason why such methods often have disappointing results.
Traders eager for action will insist that they see their favorite
pattern in the charts whether the pattern is truly there or not.
People mistakenly think they see movement in shadows and children can
see animals in clouds before they are able to read. Can these people
somehow restrain their own creativity in order to visually examine
charts of price activity?

So now what? 

If the last three sections left you thinking that all technical
analysis is too troublesome to put to use, you're almost correct. Most
technical analysis really isn't worth using because it relates to
factors which don't directly affect the trader's bottom line. There
are only three numbers that really make a material difference in the
outcome of a trade, the price when the trader initiates a position,
the price when a trader closes the position, and the size of the
transaction. If you buy 100 units at $10 and sell then at $12, you
have a $200 profit no matter what the moving average or RSI or OBV or
point and figure chart looked like. This basic fact is at the core of
the iSigma approach to technical analysis and it is the main reason
for the results we've been able to achieve.

Other indicators? 

A document covering every type of technical analysis would require
hundreds of pages and would be superfluous to the intent of this
article. That doesn't mean we want to leave any questions unanswered.
If you have questions concerning another form of technical analysis
that we didn't address here, please follow one of the contact links on
this site and let us know.

For more information, go to http://www.isigmasystems.com